In 1973, Princeton professor Burton Malkiel wrote A Random Walk Down Wall Street, an influential stock market book that put forth a financial theory (the random walk hypothesis) that stated stock market prices follow a path that consists of a succession of random steps and therefore cannot be predicted.
Well, looking back at 2016, sure looks like a random walk, the year brought us just about everything and it sure felt like it was random. You be the judge.
But first, the numbers:
How 2016 Started and Ended Were Dramatically Different
The stock market opened with an alarming drop in the first few days of the year – in fact, it was the worst 5 days to open a year dating back to 1897. This continued through mid-February and by Valentine’s Day, the market had dropped by about 10%. But then the market came roaring back and finished the quarter up about 11% from mid-February through the end of March. For the next seven months, a lot happened, but the markets didn’t move much. In fact, for the next seven months, the market moved up about 2%. Then post- Election, the DJIA surged 1600 points and finished in very positive territory – within a whisper of 20,000. A down and then up year - or Random Walk.
The Big Winner In 2016 - Small Companies
Small-cap stocks had a terrific year. As measured by the Russell 2000 Index, small cap stocks produced a 21.6% return in 2016. Value-style stocks outpaced their growth stock counterparts – by a whopping 10 percentage points in the large-cap Russell 1000 Index and by a truly staggering 20 percentage points in the Russell 2000.
Returns from the U.S. markets outpaced all other major markets around the globe:
Along the way, there was some positive economic news:
What Else Happened
The Brexit vote and the election of Donald Trump were probably two of the more significant events
this past year – at least in terms of catching most people by surprise. Not only did pollsters, journalists and experts predict these events incorrectly, but they also predicted the consequences of these events incorrectly as well. Score two more for the Random Walk theory.
So Now What?
This is the question on everyone’s mind and one where there is no shortage of predictions. Some suggest that our current bull market – now in its seventh year – is getting long in the tooth and we are due for a major correction. And by some barometers the "stock market" could be considered expensive, using such measures as P/E, CAPE, and other relative valuation measures. While others suggest this bull market has a lot of room to run, due to the low interest rate environment and expected corporate earnings. As a financial advisor, I tend to subscribe to the Random Walk hypothesis - equity markets go up over time, but predicting the path of those returns is next-to-impossible and trying to predict these movements is a waste of time.
Instead, I remind my clients that successful investing requires a long-term approach. Many people admire the actions of Warren Buffett but very few people act like Warren Buffett. And surprisingly, you can follow what he and other successful investors do...they set a plan and stick to it during both good and bad times, because markets do seem to move in a random walk. Having a well-thought out plan will provide comfort no matter who is President, what the Fed does, whether the UK leaves the EU or any other macro event that might come out of left field.
Why trying to time the market isn't the best investment strategy - in fact it's not a strategy at all.
If 2016 taught us anything, it’s the importance of not trying to time the market and not letting so-called experts or pollsters talk you into trying to time the market.
Exhibit A - January 2016 Economists, financial writers and so-called experts had high hopes going into 2016. And then the markets gave us:
Did you sell your equity positions on January 21st because you thought the market would continue to crater? If you did, then you missed the Dow skyrocketing over 1,000 points between the lowest point on January 20th and the end of January.
Exhibit B - November 2016 Election Remember that almost all the polls said Hillary would be our next President? And remember what virtually all the so-called experts and journalists said would happen if Trump was elected? They said the stock market would go way down – maybe even crash – because it hates uncertainty.
And on Election night, markets around the world were falling as Trump racked up Electoral College votes. Japan’s markets were off by about 5%, Mexico’s peso was getting hammered and the US futures market was down by about 800 points.
So, did you again sell your equity positions on November 10th, right after it became clear that Trump would be the next President? If you did, you missed the Dow skyrocketing 1600 points from Election Day until the end of the year, closing in on that 20,000 milestone.
Would this have made you mad?
Imagine if you:
Let’s use real numbers in this scenario: Your $1,000,000 at the beginning of 2016 year is worth about $900,000. Everyone else that stayed in the market saw their $1,000,000 grow to $1,120,000. That’s a $220,000 difference or the price of a modest home!
While I will admit that market is not inexpensive currently, you should always build your investment portfolio for the long-term (assuming you have the time), and be well diversified accross mulitple asset classes. So when the next market downturn happens - as it will - you have the opportunity to take advantage of the opportunities that will present themselves.
Make 2017 a great year!
Paul R. Rossi, CFA