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Resources/Weekly Insights
Volume 12, Edition 25 | August 21 - August 25, 2023

What to Expect When You’re Investing

Doug Walters, CFA
Sometimes the seemingly unexpected movements of the investing markets are exactly what should be expected. We delve into this conundrum in this week’s Insights.

Contributed by Doug Walters, David Lemire, Max Berkovich, Eh Ka Paw

The expected is often unexpected when it comes to portfolio returns. This may seem a contradiction, but it makes perfect sense. We dip our toes into statistics to unpack this statement.

So, what in the world are we talking about? If you think about any portfolio you own, you may have a sense of its expected return – the average performance you expect from that portfolio over time. This could be based on historical performance or guided by educated assumptions about the future. Regardless of the source of your expectations, they are likely to be wrong, at least in part.

To truly understand the dynamics of portfolio performance, you cannot focus only on returns. You must also factor in volatility… the normal ups and downs in the portfolio’s value. One way to measure this is with statistics using “standard deviation.”

Let’s take the S&P 500 for example. The average annual total return over the past 20 years is 9.8%. Using history as a guide, we could call this our expected return. The annual standard deviation over that same period is 18.7%. This statistic tells you that 68% of the time, the S&P 500 return in any given year will be 9.8% (the average) plus or minus 18.7% (the standard deviation). So, the market return is expected to fall between -8.9% and +28.5% a little more than two-thirds of the time. That’s a big range… not to mention the other 32% of the time the return is expected to be either lower than -8.9% or higher than 28.5%!

What is the purpose of this statistical spaghetti? It is to make the point that the “expected” return should almost never be expected in any given year. A look at the yearly returns of the S&P 500 over the past two decades shows one year down 37% (2008) and another up 32% (2013). What you do not see is any year with a 9.8% return. We’ve used the S&P 500 as an example, but the same dynamics play out in any portfolio.

Investments go up and down, sometimes by quite a lot lot. This is normal behavior, hopefully rewarding the patient investor with attractive long-term returns. But any single year will produce unexpected results, which is precisely what should be expected.


Total annual return of the S&P 500 over the past 20 years

Despite a 20-year history averaging 9.8% total return, performance in any one year tends to be very different, and that should be expected.

Headline of the Week

Hole Lotta Talking Going On…

Woodstock (Glastonbury or Coachella for any younger readers) for Central Bankers’ headliner wrapped his set playing all the recent hits with “Higher for Longer” and “Data Dependence,” the most anticipated. The Fed Chair’s set list in Jackson Hole did not break any new ground. Markets hoped to hear a verse or two on when or if rates would increase. The Chair held back on any firm commitments outside of the chorus; we will “proceed carefully.”

Given the number of rate increases thus far and the extent of their economic impact, the Fed Chair seamlessly transitioned to “Data Dependence.” These rate increases arguably have bought the Fed some time to assess their full economic impact before deciding whether to increase them anymore, how long to keep them elevated, and when to start bringing them down. The chorus, this time, is data that will drive future decisions. Markets remain focused on the last question but will have to wait to get more clarity.

The Week Ahead

A jobs number, a revision to Gross Domestic Product, and an inflation report will be all the rage as we head into Labor Day.

I’ll Be Gone ‘Til September

With Jackson Hole in the rear view, investors will start preparing for the Federal Reserve meeting on September 20th.

  • With a month off in August, the Federal Open Market Committee that sets interest rates should have lots of data to decide on its next move.
  • The Personal Consumption Expenditures index (PCE) on Thursday is probably the most important since this is the favored inflation gauge.
  • After the core number (which excludes food and energy) dropped to 4.1% in June from 4.6% for three consecutive months, is a sub-4 % number in the cards?
  • The Overall PCE, which includes food and energy, fell to 3% in June. Would a 2 handle in July be enough for the FOMC to stop the hikes?
  • While the odds favor a Fed pause in September, markets are concerned that another hike may be in play before year-end.

Keepin’ it Steady

Friday’s non-farm payroll report should add another data point.

  • Economists are expecting 160,000 new non-farm jobs in July to add to the roughly 1.8 million created in the previous 7 months.
  • This would be a resilient but slowing job market.
  • The unemployment rate is expected to remain steady at 3.5%.
  • Also important is the number of job vacancies. The June number was 9.3 million, which is above the pre-COVID level of 7.5 million.

Look Again

U.S. Gross Domestic Product (GDP) for the 2nd quarter will undergo another revision.

  • This is the 2nd revision and is expected to be revised a tad higher to 2.5%.
  • The rebuilding of inventory levels from a decline in the 1st quarter, private domestic investment, defense spending, and easing inflation are the drivers of the economic expansion.
  • For interest rates, good is bad. A stronger economy is another excuse for the Federal Reserve to hike some more, especially if inflation continues to be stubbornly sticky.

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