Rapid Changes……what they mean

From early October until October 29th, the S&P 500 declined approximately 10%.** Stock markets throughout the world incurred similar and even worse losses. While we recommend holding a globally diversified portfolio of stocks, we are using the S&P 500 for illustrative purposes here.

Since October 29th, stocks have rebounded significantly, recouping 1/2 to 2/3 of their losses, depending on the specific asset class.

These are some of the lessons from the past 6 weeks…..

  • Not reacting to news, commentary and dire stock market predictions is almost always the right course of action. Not reacting is actually a conscious decision.
  • Markets can and do change suddenly. You need to be able handle sudden movements and volatility.
    • While US large stocks were at near all-time highs in early October, and some thought they were “over-valued,” the swiftness of the decline was not clearly predictable.
    • In a similar manner, it was hard to predict the very quick and significant recovery that has occurred since the October 30th bottom.
    • Could you have accurately timed both the recent top and bottom of these moves?  We doubt it.
  • Our disciplined investment approach can be beneficial in the long term and short term. We adhered to our clients’ long term investment policies, and rebalanced accounts as appropriate.
    • For those who added funds during this downturn, we took this opportunity to buy low and rebalance to asset classes that have not been performing well.
  • This discipline of buying more of the poor performing asset classes makes sense, if you think of groups of stocks like items at a store which have gone on sale. They were now cheaper. Stocks after the decline represented greater values than they did when the prices were higher.
    • You buy things when they are on sale at a store, right? Stocks that have had quick declines, and especially if most things in the world have not changed that much, are like a sale at a store. Stocks that have dropped in price would now have greater future expected returns, so they are a better value at the lower price.
  • The most cited reason for the decline was the talk and action of the Federal Reserve to raise short term interest rates. While this may have been a cause, or contributing factor, it is hard for us to believe that institutions or retail investors did not anticipate the recent Fed moves or their projections for future interest rate increases. We think their actions have been well telegraphed and are quite reasonable, given the strong state of the US economy. The Fed funds target is currently 2-2.25%.
    • While we are not making interest rate predictions, we want you to realize that it is very likely the Federal Reserve will raise short term interest rates by .25% in December, and then at least two or three times in 2019, by .25% each time. Thus the Fed funds rate could be in the 2.75%-3.25% range by the end of 2019.
    • The two year US Treasury Note is almost 3% today. The Fed projections imply that the 2 year yield could likely rise to 4-4.25% by the end of 2019.
    • This means that for the fixed income investments of your portfolio, they will generate more income as your current investments mature and are reinvested at higher yields.
  • It is also hard to predict the movement of other assets, like the price of oil. In the past few weeks, the price of oil has declined by 20%, which is considered a bear market (drop of 20% or more). I don’t know of any financial institution that was predicting this type of decline. Most financial forecasters and bets in oil futures were predicting oil to go higher this fall, and certainly not far lower, based on Wall Street Journal articles over the past few days.
    • This decline in oil is good for the US economy for many reasons. It reduces inflationary effects, which may mitigate the cost of interest rate increases to borrowers. It enables consumers to spend more. It reduces material costs.
  • Many analysts cite the uncertainty preceding the midterm elections as contributing to the October decline. Clearly, removing uncertainty does help investor psychology. However, if uncertainty was part of the cause for the decline, why did stocks increase in the days before the November 6th election?
    • This re-emphasizes our long standing recommendation to avoid most political news when making investment decisions. While it may seem logical to want to factor politics into your investment strategy, it is not practical and often times will lead to poor decisions.
    • In our opinion, stocks are unpredictable in the short term. So don’t try to make predictions and take short term actions.
      • In the long-term, stocks follow corporate earnings and successful companies adapt and overcome political and other challenges.

The bottom line is that in the short term, stocks are volatile. That is why we develop your asset allocation to be appropriate for your goals and needs, as well as your ability to handle the short term risks and volatility of the financial markets.

We want you to be secure, so you have adequate funds to endure market downturns and be able to sleep well at night, regardless of how the stock market is performing.

 

**The Standard & Poor’s Composite 500 Index consists of 500 of the largest companies based in the U.S. The companies in the Index change frequently over time, as companies grow, fail, merge and get acquired.
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