The past six weeks or so, since the beginning of September, have been pretty unsettling for stock market investors. After three years of annualized price returns between 18% to 19% per year for U.S. large-cap and small-cap stocks through the end of August, the period from Sept. 1 to yesterday’s close has seen declines of about 7% for stocks of all types. That matches the worst multi-month decline over those three years for most stocks. (Small-cap stocks had a maximum decline of about 11% in the fall of 2011). International stocks didn’t fare as well over that three-year period, and have performed worse than U.S. stocks over the past six weeks. Does this mean the bull market is over and people should sell stocks? Far from it.
All markets need some volatility to make price discovery and investment research viable. No market – bonds, stocks, gold, oil or real estate – goes up year after year without some reversals. Markets are also wired to accept bad news more than good; by that, I mean traders and investors always look for a dark cloud, even when news or data releases are good. For example, U.S. investors have had to digest the following events and issues over the past few months: an Ebola virus outbreak, economic weakness in Europe, slowing growth in China, continued tensions between Europe and Russia over Ukraine, multiple wars in the Middle East and the ongoing dissatisfaction with the state of U.S. domestic affairs topped off by a looming mid-term election. But if we examine the facts, here’s what we see:
- U.S. household net worth has rebounded to a level 20% higher than the peak prior to the decline in 2007.
- Total debt for households and nonprofit organizations equaled 77% of gross domestic product, the lowest level since 2002. Declines in household liabilities are mostly due to lower mortgage debt.
- The federal budget deficit is falling.
- Oil declined to a near four-year low, and average gasoline prices are down 13% from a high in April, potentially putting more money in consumers’ pockets right before the holiday season.
- Predictions now are for a milder winter this year compared to last; with potentially lower heating fuel prices, that’s good news, too.
- The dollar has climbed 5% since June, making imported goods look more attractive.
- Unemployment is lower, more people are working and wages are beginning to rise in some sectors.
- Interest rates are low and have declined in spite of constant predictions of a rise over the past 5 years.
There are always a broad range of views about any event, positive or negative, that offer likely outcomes and their potential impact on the financial markets. Investment professionals struggle to consistently add value for clients by correctly analyzing the result of all of these constantly changing macroeconomic events. History, however, suggests that those looking for certainty around such events before investing could be setting themselves up for a long wait. There is always something to worry about. Is risk being appropriately priced? Are prices being kept too high and is volatility being unnaturally suppressed by the central banks? Will Europe rebound, and when? Who will triumph in all the military struggles we’re watching? Will China really manage a ‘soft landing’ for its overheated economy? Will there be an Ebola epidemic in the U.S.? What is the average investor supposed to make of all this conjecture?
We believe there is a much simpler approach. It begins by accepting that the market price for an investment is a fair reflection of the collective opinions of millions of market participants. This means we do not bet against the market, we work with the market. We build diversified portfolios around what is known of expected returns according to your particular circumstances and risk profile. It does not mean constantly reacting to the opinions of market pundits about what might happen tomorrow, next week or next year. Nobody – repeat, nobody – knows what will happen. Staying disciplined and focusing on the things that you can control, which are asset allocation, regular portfolio rebalancing and investment expenses, are the key ingredients for long-term success. Our signal for rebalancing your portfolio is the need to maintain or adjust YOUR asset allocation, not media speculation and fear-mongering. Remaining calm and focused on this strategy allows us to benefit during periods of volatility.
Is volatility back? Yes. Are we worried? No.