Equity markets around the world have officially crossed into “correction” territory, meaning they’ve pulled back by more than 10% from their all-time highs. As such, we thought it might be helpful to repeat our views on the current market, then to step back and give a broader perspective on the markets that we hope you will find helpful.
• Trade tensions with China, the Fed, and concern over a slowing global economy are at the heart of the market’s concerns. However, on balance, we believe these issues to be transitory and that equity markets are more likely to rise in the next six months than they are to fall. Additionally, the risk of recession continues to be fairly low.
• Corrections are common-place, and even healthy, for the markets. Historically, we get a correction once every eighteen months looking back over the last one hundred years. Most people are surprised by this, and even more surprised that we’ve experienced eight downward moves of this sort in the last decade. What’s more interesting is just how quickly these things tend to reverse, with the average correction over this past decade coming in at 13% and taking an average of less than six months to recover to new highs.
• Yes, the economy is slowing a bit, and earnings will follow suit as we move into 2019. But remember that earnings were up roughly 30% in 2018 due to tax reform and a strong consumer. The 7 to 9% growth forecasted for 2019 is still a very healthy level of expansion. And guess what happens when earnings go up 30% and stocks actually decline in value……stocks get much cheaper! We have seen valuations drop by more than 25% this year (see PE Ratio Chart below), leaving equities at very attractive levels. Said another way, good things are on the horizon for stocks.
This is where we want to step back and give a broader perspective on investor behavior and the markets. When the stock market starts tumbling it can be tempting to abandon ship by selling assets and moving into cash. The fear of losing money is real. The fear of making a mistake through inaction is real. We recognize these things. But one of our most important jobs as advisor is helping a client to navigate those fears in a way that is not detrimental to their long-term financial health.
History has taught us that one of our greatest ‘value-adds’ as an advisor is keeping a steady hand amidst the storm.We can actually quantify this value as Dalbar and Vanguard publish studies on investor behavior each year looking at the cost of fear-based selling decisions. In the most recent Dalbar study, individual investors under performed the S&P 500 by more than 5% per year for the last five years. Longer-term results are even worse as individual investors have under performed the index by 6% per year over the last thirty years….an absolutely devastating result. Said another way, emotion-based investment decisions cut the rate of return by more than half. The reality is that corrections do not last, as noted earlier in this article. Even bear markets, defined as drops of 20% or more, do not last.
We’ve experienced fourteen such markets over the last seventy years and, on average, full recovery took less than two years. Remember the 20% decline in 2011: the worst pull-back of the decade? It was rooted in a debt-ceiling crisis and was a challenging time for investors. Yet it was completely erased in 145 calendar days and the market has risen to significantly higher levels since then.
“The stock market is a device for transferring money from the impatient to the patient”
In addition to keeping a steady hand in turbulent times, we also look for market displacements that might add value to our client portfolios. Please see ‘Opportunity Amidst the Volatility’ below describing a recent trade we made to take advantage of this type opportunity. In the meantime, we are confident in how our portfolios are positioned for this market. If you’d like to talk this in more detail, or your portfolio in specific, please do not hesitate to call.
— The Investment Committee
In a perfect world, equity markets would move in steady fashion with minimum volatility, such as what we experienced for most of 2017. But the reality is that volatility and market corrections are part of the normal life-cycle of any market. Better yet, we can often find unique opportunities in the midst of significant volatility. To quote Warren Buffet once again, it pays to “be greedy when others are fearful.” Here are two recent examples:In early 2016, we found ourselves in the middle of what would become a 14% stock market correction. Because the upside potential of a buffered note increases with stock market volatility, we were able to purchase an attractive 3-year buffered note in client accounts that just matured on January 17, 2019. This “bond-based” note returned more than 21% over three years, well ahead of the BARCAP’s total return of roughly 6% for the same time period. This buffered note was a 15% plus winner.In similar fashion, we just purchased a five-year “bond-based” buffered note in client accounts with a 20% down-side buffer and greater than a 36% return cap for its 5-year term. These are significantly better terms than what we’ve seen since early 2016. We fully expect this to be a big winner in client portfolios once again.