How one sentence from one man can spark a major rally…

July
30

Written by: Jon McGraw

“Within our mandate, the ECB is willing to do whatever it takes to preserve the euro and, believe me, it will be enough.” –Mario Draghi, European Central Bank (ECB) President

It’s quite amazing how one sentence from one man can help spark a major rally in stocks, bonds, and the euro currency. Draghi’s comments last Thursday in London represent a significant ramping up of the ECB’s willingness to use its resources to hold the euro together and investors responded enthusiastically. On the day of Draghi’s comments:

  • The euro and the British pound each gained more than 1 percent against the U.S. dollar.
  • Stocks were positive in nearly all European markets.
  • Italian and Spanish indexes each jumped more than 5 percent.
  • The Spanish 10-year bond yield dropped nearly half a percentage point from the day before and the 10-year Italian bond yield was down a similar amount.
  • The S&P 500 index rallied 1.6 percent.

Sources: The Wall Street Journal; CNBC

Between Draghi in Europe and Fed Chairman Ben Bernanke in the U.S., central bankers seem to be exerting an outsized influence on the markets. Normally, you expect markets to roughly trend with corporate earnings.

Speaking of earnings, several high-profile companies including Amazon, Facebook, and Starbucks, fell short on their second quarter earnings numbers released last week, according to CNBC. Overall, earnings for the companies reporting so far this quarter have been a bit on the light side, according to CNBC.

While earnings ultimately matter in the long run, today’s markets seem focused on the support provided by central banks. And, yes, an up market is an up market regardless of what’s propelling it. However, for long-term sustainability, we need the markets to go up based on their earnings growth – not artificial stimulus.

 


Data as of 7/27/12

1-Week

Y-T-D

1-Year

3-Year

5-Year

10-Year

Standard & Poor’s 500 (Domestic Stocks)

1.7%

10.2%

7.3%

12.2%

-1.0%

4.4%

DJ Global ex US (Foreign Stocks)

0.9

1.4

-16.9

2.3

-6.6

5.8

10-year Treasury Note (Yield Only)

1.6

N/A

3.0

3.7

4.8

4.5

Gold (per ounce)

2.7

2.8

-0.4

19.2

19.6

18.2

DJ-UBS Commodity Index

-1.9

2.0

-13.1

5.1

-3.4

4.0

DJ Equity All REIT TR Index

1.0

17.2

13.6

29.4

4.9

11.3

 

THE BEST AND THE WORST DAYS IN THE STOCK MARKET tend to occur rather close to each other and that has major implications for how to be a successful investor.

While it’s tempting to try to aggressively “time” the stock market and be in on the best days and sitting in cash on the worst days, that’s not a viable strategy. The chart below shows how just a few days each decade made a profound impact on the performance of the market over that decade.

 

 Decade

Annualized Return by Decade

Return Excluding 10 Best Days

Return Excluding 20 Best Days

Return Excluding 30 Best Days

Return Excluding 40 Best Days

1970s

1.6%

-2.3%

-5.0%

-7.2%

-9.1%

1980s

12.6

7.6

4.6

2.0

-0.4

1990s

15.3

11.0

8.0

6.0

3.0

2000s

-2.7

-9.2

-13.2

-16.9

-19.5

Source: BMO Capital Markets

For example, during the 1980s, the S&P 500 had an average annualized return of 12.6 percent. However, if you excluded the return of the 40 best days during that decade, then the return would have fallen to a negative 0.4 percent. In other words, just 40 days out of that 10-year period accounted for all of the return for the decade. Wow!

Now, you also have to know that missing the 40 worst days during the decade would have a profound positive impact on your performance. But, here’s the rub – it would take perfect foresight to know in advance when these 40 best and worst days would occur. And, of course, none of us have that.

What makes aggressive timing even more difficult is that these best and worst days often happen pretty close to each other. BMO Capital Markets discovered that since 1970, more than 50 percent of the 40 best days occurred within two weeks of one of the 40 worst days! So, imagine this… the stock market has one of its worst 40 days for the decade and you are lucky enough to be sitting 100 percent in cash that day. Now, realistically, after a big drop like that, are you going to have the nerve to jump 100 percent right back in? If you didn’t, you’d miss more than half of the 40 biggest up days since those big up days often occur within two weeks of a big down day.

The lesson here is simple. Markets are volatile and the price of long-term return is enduring the pain of periodic declines.

Weekly Fun – Think About It…

“The most important thing in the Olympic Games is not winning, but taking part; the essential thing in life is not conquering, but fighting well.” –Pierre de Coubertin, founder of the modern Olympic Games