“Volatility in the up direction is not a problem – it’s only downward volatility that offers discourse.”– Coreen T. Sol
What’s behind this pleasant surprise? While there are several factors, the most significant reason is the Like many discoveries, the popular motion sickness medicine Dramamine was discovered by accident. In the late 1940s, doctors at Johns Hopkins Hospital were testing new combinations of antihistamines on allergy patients. By serendipity, one patient participating in the test to cure her hives just happened to also suffer from motion sickness. Dramamine failed to cure her hives, but she reported to the doctors conducting the test that her motion sickness was cured. Since this fortunate accident, Dramamine has helped millions of people prevent motion sickness, even on roller coasters.
To the best of our knowledge, Dramamine’s efficacy doesn’t extend to stock markets. If the volatile start to 2016 is a sign of things to come, we need to get scientists working on that cure right away.Just how are markets doing so far in 2016? There’s good news and bad news. We’ll start with the good news. Markets have set numerous records in 2016 and it’s only February. So what’s the bad news? Markets have set numerous records and it’s only February. To wit:
- Worst opening week ever for both the Dow and the S&P 500
- Worst opening two weeks ever for the Dow and the S&P 500
- 2nd Worst opening three weeks ever for the Dow and S&P 500
- Worst January performance for stocks since January 2009
- U.S. stock values were down $2.7 trillion as of the January 20th closing low
- Oil prices had declined by more than 25% by January 20th
If not for a strong rally both in equity and oil prices over the last six trading days of the month, things would have been even worse. Stocks resumed their decline in February and traded below the January lows before finally reversing course and recapturing some lost ground. With ongoing concerns about the health of the domestic oil industry, European Banks and the Chinese economy as well as continued tensions in the Middle East and rising tensions off the coast of China, there are plenty of issues to keep market volatility elevated. Where’s the Dramamine for stock market gyrations when we need it?
One approach that has proven successful over numerous market cycles is to invest in higher-quality stocks. While definitions of quality differ, high-quality companies generally have strong, consistent profit margins and solid balance sheets. In addition, we would include prudent use of capital and a proven management team in our definition. High-quality stocks are likely to avoid the wide price swings experienced by “hot” stocks when performance is driven more by emotion than fundamentals. Like right now.
Quality stocks work well in the current environment for a few reasons. High-quality stocks tend to be large, established companies that have successfully weathered past economic slowdowns and recessions like the current environment so shareholders are more likely to hold on to these stocks. In addition, stocks of quality companies are seen as a “safe-haven” for nervous investors to wait it out. This wave of buying helps buoy the stock price. High-quality stocks also tend to have lower price volatility in all environments. This characteristic hinders performance in up markets, but is able to really shine when fear is in control. By limiting losses compared to the broader market, “getting back to even” comes faster. It’s for these reasons we allocate a significant portion of our clients’ equity money in this strategy.
So how’s the strategy working now? One way to answer that question is by comparing the performance of high-quality stocks with low-quality stocks and the S&P 500. As an added bonus, the higher returns have been accomplished with lower price volatility.
Would you like to know more about high quality stocks? Do you have questions about the markets? Have your goals changed recently? Let us know!