It’s Déjà Vu All Over Again: 1994

The volatility in the stock market AND bond market over the past few days has everyone concerned.  Forget that the US market is still up over 10% for the year. We all tend to get very myopic in our vision when the stock market starts to waiver.  Especially when bonds, which are supposed to protect us in down markets, are also losing money.  It can make the thought of just selling everything and going to cash seem appealing.  But as history reveals, that can be a very costly mistake.

In the past week we have seen global markets enter a significant pullback and interest rates rise sharply.  It is strangely similar to what happened in 1994.  After several years of strong markets and a growing economy, Alan Greenspan (Chairman of the Federal Reserve) looked to pull the reigns in by allowing interest rates to rise.  What ensued was not pretty.  In response to higher rates the bond market was devastated.  The estimated worldwide loss in the bond market that year was $1.5 trillion.  The stock market reacted in-kind and the S&P 500 lost 9.7% from its January high point to the April low point.  Below is the return over February and March for the US stock and bond markets in 1994.

Investors understood that the stock market had its ups and downs but with both stocks and bonds moving down in lock step many people were at a loss of what to do.  A lot of people then were thinking the same thing they are thinking right now and they were considering pulling the plug on investing in anything.  All cash seemed like a smart way to go.  That is an understandable thought, but how would it have turned out for those people in 1994?  Fast forward three years and we see a much different picture.

Over just 3 years (a nanosecond in an investing life time) both the stock market and bond market had extremely strong returns. Both markets came back quicker and stronger than anyone could have anticipated.  In 1995 alone the S&P 500 returned a whopping 37.6% and the US Aggregate Bond Index returned 18%.  Anyone that went to cash in 1994 absolutely was left in the dust.  So what are the key takeaways from 1994?

1. Rising interest rates does not guarantee negative returns for bonds or stocks.  We don’t know what will happen, but as 1994 revealed both markets can be very strong in such an environment.
2. Don’t make investment decisions based on forecasting interest rates or any other market condition.  You might luck out and miss a temporary pullback, but the market will ultimately make you look very foolish over the long term.  Investing decisions should be based on your long term financial goals and those should not change based short term market forecasts.