Naughty or Nice? Notes on Current Market ConditionsSubmitted by Bernhardt Wealth Management on December 31st, 2018
Many investors may be feeling as if they got coal in their stockings for Christmas, given the 650-point fall in the Dow Jones Industrial Average (DJIA) in its Christmas Eve trading session. The S&P 500 and Nasdaq indices performed similarly, falling 2.7 and 2.2 percent, respectively. These drops, coming on the heels of a 1,600-point fall the previous week, resulted in the market’s worst December performance through Christmas Eve since 1931. Of course, I’ve written here and elsewhere that volatility is a characteristic of this market, and subsequent events proved the case, once again. The session following the Christmas break saw the DJIA up 1,000 points, and, after falling back hundreds of points during the next session, actually closing up just over 200 points. On Friday, the market was almost calm by comparison, with the DJIA down just over 70 points and the S&P 500 off by a fraction of a percent.
What should investors make of all this volatility? As we frequently remind our clients, when the market environment looks worrisome, it’s important to maintain a disciplined, strategic approach, rather than reacting emotionally. We have listed three principal concepts below that will help investors stay on track, even during turbulent markets.
Maintain a historical perspective. As Oppenheimer equities analyst John Stoltzfus said in a recent interview with CNBC.com, “Putting the recent equity market declines into historical context lessens their sting.” Blackstone investment strategist Joe Zidle further noted, “If the market closes down for the year, which seems likely, it will be only the 13th time . . . since 1960.” In this connection, it might help to take a look at the last five years of performance of the DJIA as illustrated in the accompanying chart. Of course, it is even more impressive if you look at the trend from 1900 to the present.
As we continue to counsel our clients, several factors are currently weighing on the stock markets. Among these are the partial government shutdown, trade worries, the current rising interest rate environment brought about to some degree by the current monetary policy of the Federal Reserve, and recent comments about Fed Chair Jerome Powell that the market has perceived as a source of uncertainty. It is important to remember that these are temporary factors that the market will eventually absorb into its pricing decisions. In fact, as Treasury Secretary Mnuchin’s recent comments underline, none of these factors necessarily indicate fundamental problems in the U.S. economy, a view echoed by Zidle: “I think there’s a massive gap between sentiment and fundamentals.”
Another important factor, especially considering the dramatic swings, both positive and negative, that we are currently seeing, is the effect of automated trading systems and algorithms, coupled with high-frequency trading (HFT) strategies employed by some trading programs. Though some may think that actual humans on the stock exchange floor are making these drastic buying and selling decisions that are sending the markets on a rollercoaster course, the fact is that many of these highly sophisticated, automated programs are executing market orders according to certain predetermined parameters, which adds to the type of volatility we are seeing.
While it is certainly true that there have been periods of negative price performance in the stock market, it is just as clear that the overall trend—for the last 118 years, at least—is up. In other words, investors who remain patient and who stay invested have typically been rewarded for waiting out temporary downward adjustments in stock prices.
Practice proper diversification. Just as it is impossible to predict precisely when the market will move up or down, it is also impossible to predict precisely which stocks or even group of stocks will perform best during any given time. For this reason, we coach our clients to invest in broadly diversified holdings as an effective hedge against price volatility. In fact, as a recent article from Dimensional Fund Advisors reminds us, diversification—not only among different industry groups, but also among markets of different countries—allows investors to “capture returns wherever they occur.” In other words, while the U.S. markets may be going through a period of downward adjustment, markets in other countries may exhibit better performance. In fact, for the ten years ending in 2017, U.S. markets led the world only once—in 2014. In each of the other years, other countries’ stocks outperformed. Proper diversification allows investors to capture opportunities along a much broader front, especially since nearly half of the world’s market capitalization lies outside the borders of the U.S.
Align asset mix with risk tolerance and investment life stage. Clearly, investors who are retired and utilizing their portfolio earnings as regular income should have a different asset mix than younger investors who are in the building phase. As we work with our clients to insure the proper blend of equities and fixed-income securities, we remind them that a down stock market affects different portfolios in very different ways. For a typical retired client with 50% of the portfolio in fixed income holdings and 50% in equities, even a drastic downdraft in the stock market is only influencing 50% of the assets. Suppose such an investor were holding a portfolio made up predominantly of 2-5 year U.S. Treasury securities, currently yielding just under 3%. With the stock market off its 2018 high by about 20%, that investor would be showing a 20% loss in 50% of the portfolio: a total of about $100,000 for a $1 million portfolio. Meanwhile, the rest of the holdings continue to pay regular income to the investor, and, if the investor is holding dividend-paying stocks in the equity portion, those payments are likely unaffected as well. The retired investor typically enjoys an uninterrupted income stream, with the excellent possibility that, if they remain patient, they can expect to see the equity portion of the portfolio return to previous values and, if historical trends perform as they have, go even higher. For investors with the proper asset balance, dire financial headlines need not create undue anxiety.
We all benefit from efficient markets. With literally millions of individual buying and selling decisions being made every second, the collective effect is that the market is constantly receiving and digesting information from an almost infinite variety of sources, resulting in pricing that reflects all that information. No individual is “smarter” than the market, and the market is not “punishing” anybody. Instead, it is doing what it always does: converting information into value in the most efficient way possible. Rather than reacting emotionally to the attention-grabbing headlines in the media, investors should review their overall strategy, watch for opportunities to develop, and remain on course toward their long-term goals.
We have one more trading session left for 2018—today, December 31. The market may have another day of falling prices like Christmas Eve, or the session could see prices rising rapidly as they did on the day after Christmas. Or, prices could remain basically unchanged, as they did on Friday. But whatever happens, your best resource in any kind of market is solid, professional, research-based advice, delivered with your best interests foremost. If we can help or answer any questions, please call us at the office.