The first quarter of 2018 saw the U.S. stock market increase 7.12% within the first month. Then it fell from its highest point by 10.62% to -3.50%. By the end of the quarter, U.S. stocks had stabilized with a cumulative return of -0.64% .
In our investment Review of calendar year 2017, we wrote about the remarkably low volatility experienced by investors in the stock market, complemented by a high return over the period. Investors love a high return over a period of time with a low level of volatility experienced. We summarized part of our outlook for 2018 by stating: “We believe—and it’s not going too far out on a limb—that 2018 will bring more asset price volatility than was experienced in 2017.”
Historical context is helpful in evaluating why we made that statement and for the perspective it gives to the recent ups and downs of the U.S. stock market.
Over the past 20 years, normal levels of U.S. stock market volatility ranged from 10.45% to 19.41% . The average one-year realized volatility was 14.93% . The stock market’s average annual return over the 20-year period was 6.74% . That’s 0.45 units of return per unit of “risk”—which is normal. When in 2017 the U.S. stock market returned 21.13% with 5.88% realized volatility, it produced the extraordinary result of 3.60 units of return per unit of risk.
This was an outlier and it came from two components, viz., a return well above average and the lowest 12-month level of volatility experienced in the 20-year period. Believing that that combination would not repeat, and further that the risk measure would be higher was a no brainer.
The volatility upturn from the end of 2017 hasn’t even brought the most recent 12-months’ realized volatility within the middle 50% or normal range. The recent movements in the U.S. stock market were not extreme—they’re merely approaching normal levels.
Returns must also be viewed within the proper context. -0.64% for a quarter is unexciting. 13.81% over a year is exciting. And this is exactly the return over the last 12 months.
Although the first quarter clearly was less stable than the preceding three quarters, it ended with stock prices approximately where they were at the end 2017. In the context illustrated in the chart above, over the past 12 months—including the first quarter of 2018—investors in U.S. stocks returned 13.81%, over two times the 20-year average return of 6.74%. It produced this return with realized volatility of 9.34%, less than two-thirds the 20-year average of 14.93%.
Finally, as we’ve repeated over the years, the U.S. stock market is only a portion—albeit a sizable portion—of the global stock market. At the end of 2017 we claimed that although public companies composing the U.S. stock market appeared relatively expensive compared to their history, “Emerging Markets’ stock hit their low CAPE ratio as recently as February 2016, which showed them at a better bargain than in the depth of the financial crisis in 2009!” Our emerging markets allocation ended the first quarter up 1.96% , which, for perspective, is an annual pace of 8.10%.