Bad start to equities in 2014: is it time to panic?

After the bad start to the year many commentators refer to the notion that a negative January usually implies a negative return for the full year. If that is the case, should we worry and reduce risk in our client portfolios?

To tackle this issue, let’s start with the numbers. Is it a true statement? A study of the S&P 500 shows that since 1950 – 63 years ago – the market opened in negative territory 24 times. In the 24 years with a negative start, the market closed in negative territory 13 times.

The average market return for these 24 years is -4%. However, the average return from February to December for these 24 years is 0%.

In short, without becoming too analytical, it appears as though the numbers warrant some caution.

As we know, there are always exceptions. In 2003 the S&P started on the back foot only to close the year with a 26% gain.

The numbers might be a red flag but we do not find comfort in historical numbers. We try to formulate a long-term view but we realise a short and sharp correction can be detrimental to the creation of wealth over the long term. We need to look at equity performance in a broader context. January 2014 is just one month in the long-term investment journey of our clients. The market performance should be viewed against a very strong performance recorded from the lows in 2009. Over this period company earnings recovered off a very low base but share prices also ran hard as the market rerated on the back of investors who were prepared to pay up for risky assets. A correction or pullback from these levels is certainly not new.

The correct question to ask is whether this correction should be seen as a prelude to a bigger and a sustained correction in equity prices. With the current evidence – about five years from the previous recession – we believe 2014 might well be a period we would consider a mid-cycle year. During mid-cycle years equity markets generate low returns, but they do not mark the end of the bull trend. They include the years 1984, 1994 and 2005.

Every decade has experienced a year of flat returns as monetary policy starts to tighten. If the market is not overly expensive and we see a continuation of earnings growth in the cycle, the asset class is likely to perform well in the cycle.

We do not think global equities are expensive and we still expect inflation-beating earnings growth. Alternative asset classes are not viable long-term solutions. Hence we do not think this is the start of a bear market – or that our clients should panic out of this risky asset class.