A Random Walk Down Wall Street
In 1973, Princeton professor Burton Malkiel wrote A Random Walk Down Wall Street, an influential stock market book that put forth a financial theory (the random walk hypothesis) that stated stock market prices follow a path that consists of a succession of random steps and therefore cannot be predicted. Malkiel further suggests that since stock prices typically follow this random walk, it is therefore not possible to consistently outperform market averages.
Well, looking back at 2016, it sure looks like Professor Malkiel was onto something. Because 2016 brought us just about everything and it sure felt like it was random. You be the judge. But first, the numbers:
Further dissecting the performance of sectors, we found that:
The stock market opened with an alarming drop in the first few days of the year – in fact, it was the worst 5 days to open a year dating back to 1897. This continued through mid-February and by Valentine’s Day, the market had dropped by about 10%. But then the market came roaring back and finished the quarter up about 11% from mid-February through the end of March. For the next seven months, a lot happened, but the markets didn’t move much. In fact, for the next seven months, the market moved up about 2%. Then post-Election, the DJIA surged 1600 points and finished in very positive territory – within a whisper of 20,000.
Small-cap stocks had a terrific year. As measured by the Russell 2000 Index, small cap stocks produced a 21.6% return in 2016. Value-style stocks outpaced their growth stock counterparts – by a whopping 10 percentage points in the large-cap Russell 1000 Index and by a truly staggering 20 percentage points in the Russell 2000. Returns from the U.S. markets outpaced all other major markets around the globe:
High quality fixed-income investments produced very modest gains, as interest rates moved higher. The Barclays Aggregate Index returned a little more than 2% for the year whereas High-Yield, as measured by the BoA/ML High Yield Bond Index returned 17%.
The Brexit vote and the election of Donald Trump were probably two of the more significant events this past year – at least in terms of catching most people by surprise. Not only did pollsters, journalists and experts predict these events incorrectly, but they also predicted the consequences of these events incorrectly as well. Score one for the Random Walk folks.
Along the way, there was some very positive news from the economy, which is likely to spill into 2017. More specifically, we saw:
The market jitters returned for a short time as the race between Donald Trump and Hillary Clinton began to tighten, leading to a nine-day decline for stocks ahead of Election Day. And when it became clear overnight that Trump would be the President-Elect, markets around the world reacted negatively, and the US futures market pointed to a very unpleasant opening. But then the markets went the other way… Toward the end of the year, it seemed like each day brought another market high and more good economic news. As such, the Federal Reserve decided to boost its interest rate by a quarter-point – its second rate increase in a decade. But the Fed went further and showed increasing optimism about the US economy and signaled that it might raise rates 3 times next year.
This is the question on everyone’s mind and one where there is no shortage of predictions. Some suggest that our current bull market – now in its seventh year – is getting long in the tooth and we are due for a major correction. Others are suggesting the Dow could hit 30,000 before Thanksgiving. As a financial advisor, I tend to subscribe to the Random Walk hypothesis. I believe that markets go up over time, but predicting when and how much is a bit of a game. And predicting individual stock movements, to me, seems like a waste of time. Instead, I remind my clients that investing is only one component of financial planning. I would much rather help my clients identify their tolerance for risk and unpack their financial goals, so I can build them a comprehensive financial plan that is tailored to them. No matter who is President, what the Fed does, whether the UK leaves the EU or how the market walks around in 2017. So my clients can sleep better at night.