ACM Commentary 3Q 2017

by | Nov 13, 2017

The S&P 500 was up 4.5% in the 3rd quarter, its 8th quarter in a row of gains. The index was up 14% through the third quarter, and has not posted a negative annual return since 2008. In that time, it has now provided a cumulative return including dividends of almost 200%! This move has equity investors feeling complacent, while others more conservatively positioned are growing anxious about how to best position themselves moving forward.

Given this, we thought it might be useful to provide some historical context on the S&P, and to discuss the considerable benefits of a long-term investment time horizon with this quarter’s writing. Despite the market’s recent run, we believe that there is still plenty of room for optimism in the years ahead.


When markets make dramatic moves up or down it is important for us to remember as investors why we are investing in the markets to begin with – namely to preserve and to grow the purchasing power of our money over time. The short-term volatility in the market oftentimes distracts us from this goal because investors focus on the risk of losing money in the market, while at the same time neglecting to acknowledge the risk associated with not participating at all.

For instance, on the following page we show the performance of the hypothetical growth of one dollar in three different investment choices the S&P, 10 Year US Bonds, and Treasury Bills from 1928 through 2016. The difference in the performance of these three investments over the period is quite dramatic.

As you can see, it is not much of a contest with the S&P’s return trouncing government bonds and T-bills. Also, it is worth considering that inflation averaged 3% for the period. Due to this, investments had to return over 3% annually to maintain a constant standard of living. Put more simply, it requires $13.95 to purchase the same amount of goods today that just $1 purchased in 1928. A safe investment in US 10 Year bonds grew to $72, and even safer Treasury Bills reached just $20. They were both able to overcome inflation’s hurdle, but not by much. Meanwhile, that same investment in the S&P resulted in $3,286!


No doubt, an investment in the equity markets carries with it risk, particularly in the short run. The chart below shows the yearly performance of the S&P over the same period 1928 to 2016. The results show many peaks and valleys with high highs and low lows surrounding an average return, creating considerable challenges to be overcome by investors. Though the average return over the period remains attractive, it’s the downside volatility of the returns in the short run that tempted investors to make mistakes.

For instance, an investor placing a one-year bet on the market had a reasonable 73% chance of a positive return in any given year (the market was positive in 65 of 89 years). However, negating this benefit was the possibility of loss, which averaged -14% for the period, and surely exceeding the pain threshold for some investors.

The last few years notwithstanding, the market has been and will continue to be susceptible to swings, which result in investors being pleasantly surprised in some years and disappointed in others. Due to the market’s unpredictable nature, equity investors are encouraged to take a long-term view, which carries with it considerable advantages. First, the probability of a positive return increases with time, while downside risk is reduced. Additionally, due to the power of compounding, the more time that money is invested, the more time it has to grow. As a result, an investor with a longer horizon takes less risk than an investor looking only a year or two into the future, and has a higher likelihood of achieving a favorable return. We can show this by approaching the same 1928 to 2016 window, but framed differently over 10-year rolling periods. This is done by calculating the annualized return for each 10-year period from 1937 to 2016. In other words, the first return in the series is determined by calculating the 10- year annualized return from 1928 through 1937, the next from 1929 through 1938, and so on. The results of this subtle adjustment are good news for equity investors.

Viewing the exact same data through a longer lens mitigates the risk that is apparent in the shorter periods. For instance, an investor on a rolling 10-year investment horizon had an improved 94% probability of a positive return (the market was positive in 75 of the 80 periods the calculation was measured). Further, the average negative return was reduced to just -1%, from the previous -14%. The only negative returns being achieved in 3 consecutive periods near the end of the depression, and more recently in the 10-year periods ending in the ’07 and ’08 great recession. Fortunately, this smoothing out of volatility continually improves the further time is stretched. Taken to an extreme for instance, viewing the data over 40 years reveals something of a Goldilocks environment, with many years of returns consistent with the average return, and the lowest return in any one period being an acceptable 8.5%.

(If you are interested in viewing a spreadsheet which depicts the rolling returns on the S&P over various time periods click on this link.)


Of course, the world is uncertain and there is no guarantee that the future will emulate the past. However, history has shown the need to embrace risk to meaningfully offset the impact of inflation and preserve purchasing power.

As of this writing, the market continues to flirt with all-time highs, causing complacency among those who are in the equity markets, as well as consternation and regret for those heavy in cash. It is useful to remember that it is very difficult to time a market correction and that even if successful they prove difficult to profit from. Additionally, electing to wait out the market in cash or Treasuries, carries an expense of its own. With this writing we have simply suggested the merits of taking a longer view. To prove this point we looked at a long period of time that distinctly shows the advantages that the equity markets have over more conservative alternatives. Next, we pointed out the risk in equity markets over the short term and reduced this risk by viewing the same data over longer rolling periods. Of course, there are other more active tools available to help mitigate risk, which we will discuss in future writings.

At Alamar we believe that the equity markets continue to provide the best opportunity to improve investors standard of living over time. For us, whether to take on risk or not is less the question than taking an amount of risk that is appropriate and suitable, given each of our specific circumstances and individual investment horizons.

Thank you for your continued interest and consideration.


The views expressed in this note are as of the date initially published and are subject to change without notice. Alamar has no obligation or duty to update the information contained in this note. Past performance is not an indication of future results. Risk is inherent in investments and involves the possibility of loss. Net of fee performance is calculated using the highest fee. The Russell 3000 Index measures the performance of the largest 3000 U.S. companies representing approximately 98% of the investable U.S. equity market. The S&P 500 Index, which is a market-capitalization weighted index containing the 500 most widely held companies chosen with respect to market size, liquidity, and industry.

This publication is made available for informational purposes only and should not be used for any other purpose. This report should not be construed as a solicitation of an offer to buy or sell any security. Information contained herein was obtained and derived from independent third-party sources. Alamar Capital Management, LLC believes the sources are reliable; however, it cannot guarantee the accuracy of such information and has not independently verified the accuracy or completeness of such information.

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