U.S. and global equity markets have been in a sustained volatile patch since early summer, and a look at the S&P 500 over the last year demonstrates how the ups and downs have netted flat returns. Whether you want to blame the trade war, slowing corporate earnings growth, weakening China and European economic fundamentals, the inverted yield curve, or some combination of them all, stocks have been fighting an uphill battle.
The S&P 500 Over the Last Year
Source: Federal Reserve Bank of St. Louis1
As uncertainty grows over how much longer the global economic expansion can last, central banks and governments have been posturing to respond with fresh economic stimulus, rate cuts, or both. But at the same time, investors have been increasingly pouring into safer assets like U.S. Treasuries. As you can see in the chart below, the 30-year U.S. Treasury (red line) and the 10-year U.S. Treasury (blue line) have been in a sustained decline as demand for safety continues to rise.
Source: Federal Reserve Bank of St. Louis2
Some investors may look at the broader picture and think, “Wouldn’t now be a good time to go to cash?” If the future is this uncertain and all the signs are pointing towards a recession and weak stock performance in the short-to-medium term, why not just shift to cash and wait until the economic outlook improves?
But my message to readers is that even in uncertain times, going to cash is not a good idea. I believe that as a general rule, a high allocation to cash over the long-term raises the risk that an investor will fall short of achieving their financial goals. The two exceptions to this rule, in my view, are (1) if a person has the cash earmarked for a short-term cash flow need, say in the next year or two; or, (2) if a person has sufficient wealth that they don’t need growth to meet their financial goals. Outside of these two exceptions, I think you should plan to stay invested.
To see why timing the markets and avoiding risk by going to cash can be harmful, just look at what happens if an investor misses big up days in the market. The hypothetical table below looks at the performance of $10,000 invested in the S&P 500 between January 4, 1988 and December 31, 2018. It’s important to note that this $10,000 was exposed to two of the biggest bear markets in stock market history, the 2000 tech bubble crash and the 2008 global financial crisis.
|Fully Invested||Missed 10 best days||Missed 20 best days||Missed 30 best days||Missed 40 best days||Missed 50 best days||Missed 60 best days|
|Total Cumulative Return||1846.86%||871.60%||502.18%||296.39%||168.90%||86.56%||32.5%|
Even missing the 10 best days over that period meant leaving half of your potential total return on the table.
But here’s the real kicker: Six of the 10 “best days” in the market were within just weeks of the worst days in the market. In other words, some of the best days often happen as “v-shaped” bounces off the worst days. Going to cash on a big negative day means increasing the risk of missing a big positive day, which as you can see from the table above, can have a significant impact on total return over time.
Bottom Line for Investors
Uncertainty and volatility in the equity markets is likely to persist for the balance of the year and beyond. But an investor’s response should not be to run for cover and go to cash, in my view. I firmly believe that doing so reduces your chances of reaching your long-term goals. Instead, if the uncertainty and volatility has you nervous about what the short-to-medium term holds, I would recommend revisiting your asset allocation, where you can control your risk profile by investing in different categories of equities and fixed income – and tweaking your exposures to each.