Strength is Risk

A 1966 study by Benjamin F. King entitled “The Latent Statistical Structure of Securities Price Changes” concluded that the majority of influence on individual stock prices comes from market and sector factors rather than company-specific factors.

This conclusion is borne out by a historical analysis of past market rallies and declines, including empirical evidence from the 2000-2002 bear market, the 2002-2007 bull market, and the crushing current bear market.

It is consistent with common estimates that approximately three of four stocks rise with the market and nine of ten fall with the market.  As described in a November 21, 2008 Bloomberg article:

The worst annual decline in the Standard & Poor’s 500 Index since 1931 has dragged down every industry in the benchmark gauge and 96 percent of its stocks… Four hundred eighty-two companies slipped as the 500-stock index slumped 46 percent, poised for its biggest yearly retreat in eight decades.

Based on this market reality, KLD believes the key to attractive returns is to align portfolio exposure with market direction. The better and longer a portfolio’s alignment with overall market direction, the higher the likelihood of attractive returns.  Conversely, the greater a portfolio’s conflict with overall market direction, the higher the likelihood of poor portfolio performance.