A Volatile Start to the Year

February 2, 2016

mountain_climberStocks turned in their worst January performance since 2009. The large-cap S&P 500 index lost -5.0% as did the MSCI Emerging Markets and EAFE indexes, and the small-cap Russell 2000 sank -8.6%. Slowing growth in China was cited as a catalyst for the decline, so it’s not surprising that Chinese stocks were among the hardest hit, down as much as 15%.

According to AAII, investor pessimism has surged lately to levels last seen in 2009, but history has shown that short-term events have little long-term impact on the value of stocks, and that the best times to buy stocks has been when everyone else is selling. And history also shows that most investors do just the opposite, sell into stock market declines and buy into mature bull market rallies.

What to do now

We know that we have to accept volatility if we invest in stocks because stocks are inherently volatile. Over time, investors have been rewarded with higher returns than less volatile investments like bonds and cash. Since 1950, stocks, as measured by the S&P 500, have gained an average of 11% annualized compared to 6% for bonds. Volatility can make it tough for investors to hold stocks long enough to experience those terrific long-term results, but if we can stick it out, those gains can change our lives.

Focus on funds with strong recent returns

In sell offs, recently leading areas of the market are often hit hardest and that’s what we saw in January as previously strong U.S. large-cap growth funds and biotech funds sank. But some funds, like dividend funds and utilities sector funds, held up better than others.

Among diversified funds, dividend funds and funds like PowerShares S&P 500 Low Volatility (SPLV) did best. Most dividend funds were down only about -1-2% for the month compared to the market’s -5% drop. Most large-cap growth funds are still doing well enough to hold, but we wouldn’t add money to them at this point.

Among sector funds, consumer staples remains top ranked and utilities sector funds were among the few stock funds with gains in January 2016. Biotech and health care funds fell sharply.

Balance your portfolios with bonds

Bonds were a bright spot in January, as investors fled the stock market for the safe haven of fixed income investments. Long-term governments jumped over 3% for the month, while mortgage-backed bond funds and diversified intermediate-term funds gained over 1%.
Global bonds also gained—particularly dollar-hedged foreign bonds. Lower-quality bonds and preferred stocks, which are somewhat more correlated to stock market performance, lost between 1% and 3%.

Holding both stock and bond funds can help us manage risk and stay invested, even during volatile markets.

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