Weekly Market Recap This week saw international stock markets continue to rise from the pullback we saw over the summer, rewarding investors with a long-term strategy. US jobs figures showed continued strength remaining near historic lows, though inflation remains subdued, both in the US and in many developed countries.
Disappointing earnings releases this week from Walmart and Netflix have attracted headlines. Walmart's stock had its worst decline in 25 years; down almost 10% on Wednesday. It's worth noting that since 1980, 320 companies have been removed from the S&P 500 due to business distress according to JP Morgan research (find the full report linked below), and looking at the broader Russell 3000 index, 40% of stocks have seen a decline of 70% or more from their peak value.
The J.P. Morgan research suggests that, despite the gloomy statistics surrounding individual stocks, the prospects for tracking an index have historically been superior to the outcome of owning many individual stocks. This research suggests that historically, the returns to individual companies do not follow stock indexes as closely as one might expect. Despite the disappointing data on the performance of lagging stocks, benchmark global stock returns have been attractive in most periods of a decade or more. This is possible because only a small proportion of companies (about 6-8% of companies in most sectors) enjoy extremely high returns, while, on the other hand, a large number of companies lag the index. Statistically speaking, if you are attempting to pick stocks, you're far more likely to pick a loser than a winner.
Of course, this distribution of company returns such as this creates yet another problem for stock pickers. It means that missing out on just a small handful of strongly performing stocks can materially hurt your returns. This may be one reason why 7 out 10 US active funds underperform their benchmarks on a 10 year view according to the S&P Dow Jones SPIVA Scorecard for 2014. It's one reason why we believe tracking an index offers a better proposition than trying to beat it, and why a concentrated position in a single stock could be a risk to your portfolio.
Footnotes:
Information regarding Walmart's earnings report can be found here:
http://www.bloomberg.com/news/articles/2015-10-14/wal-mart-tumbles-after-predicting-drop-in-fiscal-2017-earnings
The full JP Morgan report can be found here: https://www.chase.com/content/dam/privatebanking/en/mobile/documents/eotm/eotm_2014_09_02_agonyescstasy.pdf
The data on the majority of active funds underperforming their benchmarks is here
http://www.spindices.com/documents/spiva/spiva-us-year-end-2014.pdf
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