This blog is the second in a four-part series on factors of return.
A review of the historical results of the market premium may help provide advisors context for client conversations about performance. (The market premium is defined as the incremental return of a broad based market index over a proxy for the risk free rate.)
Over short periods we’ve observed a volatile U.S. market premium. The standard deviation of the U.S. market premium over one-year periods, rolling one month from December 1972 to December 2015, is 17.74%. The graph above helps illustrate the volatility of the market premium over time.
There have been 153 one-year rolling time periods with a negative premium since 1972; however, a positive U.S. market premium occurred 70.41% of the time.
We see similar volatility with the international market premium. The standard deviation of the international market premium over one-year periods, rolling one month from December 1972 to December 2015, is 21.99%. The graph below helps illustrate the volatility of the international market premium over time.
There have been 197 one-year rolling time periods with a negative premium since 1972; however, a positive international market premium occurred 61.90% of the time.
We see a less volatile market premium as we extend the rolling periods. The standard deviation of the U.S. market premium decreased to 3.76% over 10-year periods, rolling one month from December 1981 to December 2015. The standard deviation for the international market premium also declined, down to 4.15% over the same time period. The chart below illustrates the decreased volatility of the premium as we extend the time frame.
Positive 10-year market premiums occurred 90.22% of the time in the U.S. and 85.57% internationally. Negative 10-year U.S. market premiums occuring consecutively remained negative for approximately 10 months on average, with the longest negative U.S. market premium lasting for 23 consecutive months, from May 2008 to March 2010. Negative international market premiums occured consecutively for approximately 10 months, on average, with the longest negative international market premium lasting for 18 months, from June 2002 to November 2003.
Reviewing performance quarterly or annually is important to ensure the portfolio is invested in accordance with a client’s long-term goals and risk preference. However, as we’ve seen with the value and small premiums, when discussing the results of an investment strategy, it is critical to maintain a long-term perspective.