Don’t Fret Over the Market’s Recent Volatility
Thursday, April 17, 2014

It certainly feels as if Mr. Market has reverted back to being a toddler: happy one minute and cranky the next. Those who own highly valued momentum stocks such as Netflix (NFLX) and Facebook (FB) have certainly felt the impact of the volatility.

Though some stocks have been whipsawing, the markets overall have been less volatile than they feel or some headlines suggest. As of last Friday’s close, the S&P was just 3.9% below its record high closing. The large-cap index has also only ended up or down by 1.5% or more four times this year. The action feels more volatile because the recent decline has occurred quickly, as downward moves typically do. Plus, last year was a calm one. I counted just eight days with a closing price change of 1.5% or greater and only four days with a closing price change of greater than 2% for all of 2013. Depending on what stocks are in your portfolio, you may have experienced more or less volatility than the S&P 500 has this year.

As to whether the recent decline is a precursor of a market correction, I couldn’t tell you. The same holds true for all market forecasters. We are about to enter what has historically been the worst six-month period for stock prices (May through October). On the other hand, optimism in the AAII Sentiment Survey is at a level that has historically been followed by above average S&P 500 returns. Neither indicator has a perfect record, so we might have better accuracy trying to predict who is going to win this year’s World Series.

What can I say is those who stayed invested in stocks all of last year have a nice profit cushion to ride out any retracement that occurs this year. Even if a painful correction of 15% were to occur (and I’m NOT saying it will), a sizeable profit will still exist for an investor who bought an S&P 500 index fund at the start of 2013.

If you are worried about the prospects of near-term weakness, reassess your exposure to stocks and your investment strategy. It’s not the market that is the problem, it’s the level of risk you are taking and the length of the time horizon you are considering. Small market fluctuations like we’ve experienced are normal. Investors who ride them out do get compensated for coping with Mr. Market’s tantrums.

CNBC’s 25th Anniversary

Financial news network CNBC is celebrating its 25th anniversary today. The network’s first broadcast aired on April 17, 1989.

I’m sure many of you have memorable CNBC moments. Mine started in 2006 off-air with me sitting in front of the camera, microphone attached to my jacket’s lapel and the live feed coming through my earpiece. Maria Bartiromo announced a breaking news headline about Israel invading Lebanon. Immediately afterward, Maria’s first question was what I thought about Israel’s military action. Talk about having to think quickly on my feet!

Since CNBC launched, financial and economic news is transmitted with a speed and at an extent that have never been the same. Though the network has contributed to the transparency and the distribution of information, the rules of investing have not changed. A long-term, value-oriented focus with a willingness to look where others aren’t remains a winning strategy.

AAII Model Portfolios Updated

The Model Fund Portfolio was up for review this month, but there were no transactions. There were also no transactions in the Model Shadow Stock Portfolio.

During March, the Model Shadow Stock Portfolio gained 0.3%, outperforming the Vanguard Small Cap Index fund (NAESX), which lost 0.3%, but underperforming the DFA US Micro Cap Index fund (DFSCX), which was up 1.0%. For the year, the Model Shadow Stock Portfolio is still down 3.4%, which trails NAESX, which is up 2.6% and DFSCX, which is up 0.6%. The Model Shadow Stock Portfolio has a compound annual return of 17.9% from its inception in 1993, while the Vanguard Total Stock Market Index fund (VTSMX) has gained 9.3% annually over the same period.

The Model Fund Portfolio performed slightly better, gaining 0.5% in March, and the Conservative Portfolio (75% Model Fund Portfolio and 25% iShares Barclays 1-3 Year Treasury Bond ETF) was up 0.3%. The Vanguard Total Stock Market Index fund (VTSMX) also gained 0.5%. For the year, the Model Fund Portfolio is now up 3.4%, ahead of VTSMX, which has gained 2.0%. The Model Fund Portfolio has a compound annual return of 9.7% from its inception in June of 2003, while the Vanguard Total Stock Market Index fund has gained 9.2% annually over the same time period.
Read Model Portfolios

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The Week Ahead

As a reminder, the U.S. financial markets will be closed tomorrow. Happy Easter!

Earnings season will hit full swing next week with 160 members of the S&P 500 scheduled to report. Included in this group are Dow components AT&T (T), McDonald’s Corp. (MCD), Travelers Companies (TRV) and United Technologies (UTX) on Tuesday; The Boeing Company (BA) and Procter & Gamble (PG) on Wednesday; and 3M (MMM), Caterpillar (CAT), Microsoft (MSFT), Verizon (VZ) and Visa (V) on Thursday.

March existing home sales will be the first economic report of note with a Tuesday release date. Wednesday will feature March new home sales and the April PMI Manufacturing index flash. March durable goods orders will be released on Thursday. Friday will feature the final April University of Michigan consumer sentiment survey.

The Treasury Department will auction $32 billion of two-year notes on Tuesday, $35 billion of five-year notes on Wednesday and $29 billion of seven-year notes on Thursday.

Local Chapter Meetings

AAII Local Chapter Meetings offer you a variety of presentations from expert speakers who will give you their view on the world of investing. A bonus of attending a Chapter Meeting near you is the opportunity to meet other AAII members who share your interest and enthusiasm for investing. You can even share the Chapter experience with your family and friends by inviting them to attend Chapter Meetings with you!

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AAII Sentiment Survey

Optimism among individual investors is now at levels not seen in 12 months, according to the latest AAII Sentiment Survey. Neutral sentiment, meanwhile, is above average for the 15th consecutive week.

Bullish sentiment, expectations that stock prices will rise over the next six months, fell 1.3 percentage points to 27.2%. Optimism was last lower on April 18, 2013. Bullish sentiment is also now below its historical average of 39.0% for the fifth consecutive week.

Neutral sentiment, expectations that stock prices will stay essentially unchanged over the next six months, rebounded by 1.1 percentage points to 38.5%. This puts neutral sentiment above its historical average of 30.5% for the 15th consecutive week. The last time a similar streak occurred was in 1999.

Bearish sentiment, expectations that stock prices will fall over the next six months, edged up 0.1 percentage points to 34.3%. The modest increase puts pessimism at a 10-week high. It also puts bearish sentiment above its historical average of 30.5% on back-to-back weeks for the first time since January 30 and February 6, 2014.

Bullish sentiment is now at an unusually low level, or more than one standard deviation below its historical average. Historically, such readings have been a contrarian signal. Optimism can stay at below-average levels for a period of time, however. It is also important to realize that many AAII members are long-term investors and do not make portfolio decisions solely based on changes in their short-term expectations.

The drop in bullish sentiment comes as downward volatility has returned to the market. The recent decline in stock prices has heightened concerns that a market top has been formed and that valuations may have become too high. Also playing a role is the pace of revenue growth, the slow rate of economic expansion and Washington politics. Keeping some individual investors from being pessimistic is earnings growth, economic expansion, the Federal Reserve’s tapering of bond purchases and low interest rates.

This week’s special question asked AAII members what they think about the decline experienced by highly valued momentum stocks such as Netflix (NFLX) and Facebook (FB) since the start of March. About 60% of respondents said these stocks were overvalued and/or that they were not surprised to see the share prices fall. A small number of respondents (5%) thought the declines are a precursor to a further decline in the broad market indexes.
Here is a sampling of the responses:

  • “About time. They were way overpriced for their revenue models and long-term outlooks.”
  • “They were overvalued and are still overvalued!”
  • “They didn't deserve their valuation and needed to be knocked down.”
  • “I am glad I did not buy into the hype or the noise.”

This week’s Sentiment Survey results:

Bullish: 27.2%, down 1.3 points
Neutral: 38.5%, up 1.1 points
Bearish: 34.3%, up 0.1 points

Historical averages:

Bullish: 39.0%
Neutral: 30.5%
Bearish: 30.5%

Take the Sentiment Survey.