In 2017, the domestic stock market went through a year of unparalleled calm, with volatility shrinking to almost nothing. Not once did we even have what is referred to as a “pullback”, which is a drop of between 5% and 9.99%.
Over the last week, we have seen a reversal of these trends, with volatility coming back with a vengeance. And we have now gone past “pullback” stage right into a “correction”, measured as a drop of at least 10% in the market indices. The last one of these events took place 24 months ago.
While our clients understand our long-term perspective when it comes to investing in the equity markets, the speed of the decline may have you wondering about our current thinking.
First, the most significant thing that has changed is investor psychology. Can you believe that this recent downturn started based upon a stronger than expected jobs report? This started a seemingly backward reasoning of what is good for the economy is bad for stocks. The fears of higher inflation and rising interest rates suddenly trumped (pardon the pun…) the solid economic numbers that we have been seeing. People became uneasy with stock prices that suddenly appeared to be lofty, and the selling began. The short-term fears were deemed more important than the long-term economic fundamentals. Despite the fact that we are seeing global economic expansion across the planet, stocks were suddenly viewed as being too risky, and were jettisoned.
So, what hasn’t changed in the current environment? Most importantly, the underlying fundamentals of the stock market are still in very good shape. Companies are largely hitting their earnings targets, employment is at excellent levels, and balance sheets in the U.S. are still looking for future benefits from the significant recent corporate tax cuts. Economic growth has been rising, not falling. Debt levels have been falling, which is a positive for individual investors. And, the market has already been prepared by the Fed that interest rates will be increasing this year as they try to “normalize” coming off of a period of exceedingly low rates.
One chart might help to put this recent downturn in better perspective. This is a chart of the Dow Jones Industrial Average since the Great Recession ended:
While the “tail” that has happened over the last week has been significant and abrupt, you can see that it loses some significance when measured over a longer time frame. Additionally, you will see that short downtrends like this have happened multiple times over the last nine years.
One of the greatest investors of all-time, Warren Buffet, has offered the following when asked about how he handles market corrections:
Corrections are normal and unpredictable – no one can say with certainty when they will occur. Trying to “time” events like this is a fools errand.
A correction is like a sale in the stock market – from a long-term perspective, valuations being reset is a good thing. If you are invested for the long haul, this can be a great time to rebalance and make some purchases at lower prices.
Don’t follow the crowd – do not panic and sell when others are doing so. Investors that allow emotions to rule in times like this are normally making the wrong decision. The best advice is to take a deep breath, and realize that this is all part of being an investor in the stock market.
Put yourself in a strong position to capitalize – try to keep some cash on hand so you can either “bottom fish” when markets correct, or not have to sell stocks at inopportune prices should you need cash to live on. For those clients who are drawing on their portfolios, this is why we like to maintain a healthy cash reserve amount at all times.
Should you have any specific questions for us, please don’t hesitate to let us know. While nobody is excited when the market starts to roller coaster like this, it is normal and natural. Remember your long-term investment focus and try to ignore the sensationalized headlines that are thrown at you. And most importantly, focus on the fact that the fundamentals remain strong.
Take care, and have a great weekend.