It Pays to Allocate

U.S. equity markets have struggled to gain ground year-to-date, posting a meager 2.7% return by mid May. Still, the S&P 500 has slowly climbed to an all-time high and a few weeks ago peaked over the 1,900 level.  Over the past year, success in the equity market was supported by a pickup in economic activity and a dampening of tail risks globally.  However, going forward investors should not be surprised by mean reversion in both annual returns and volatility.

normal volatilityAs shown by a recent JPMorgan chart of the week, the maximum drawdown (intra-year decline) so far this year was -5.8%.  This was also equal to the largest pullback in 2013.  The average annual drawdown since 1980 put these pullbacks in the -14% range.  Despite these annual pullbacks, the S&P 500 index still returned to investors an annual total return of 9.9% since 1980.

What does this tell us about stock investing?  It reinforces the notion of diversifying investments across all asset classes.  It pays to have a portion of your portfolio allocated to equities despite the volatility associated with them.

Equity markets saw stellar returns last year with minimal variance to historical standards.  Looking ahead, investors should expect a “normalization” of volatility and moderation in returns over the next few years much closer to the long-term averages.

Chart of the Week: Source, Standard & Poor’s, FactSet, J.P. Morgan Asset Management May 19, 2014