The recent stock market volatility has some people a little bit nervous. I have had a few clients ask the question, “Have we seen the peak of the market?” “Is it time to get out of the market?”
I wanted to address those questions and the general market volatility in this letter and also give some perspective on what we should expect in the markets. As investors, what are the things we should be thinking about and what do we do going forward?
One the things we need to remind ourselves is that market volatility is normal. In fact, in the US market, we see on average a 5% correction one time per year and a 10% correction about every 2 years.1 However, the last time we saw a 10% correction on the S&P index was at the end of 2015 in to 2016 (-13.3%) and we haven’t had a 20% correction since 2011 (19.4%).2
Secondly, when we see volatility, it is typically the market ‘digesting’ new information. One of the best illustrated examples was the election night of our current President. The market futures tumbled overnight, on the news of the election, trying to digest the reality of the elected President versus the person who many people expected to be elected. However, by morning the market had reversed course and the markets were up a fair amount by the end of trading the following day.3 Since then, those who stayed invested have been rewarded with a very nice rate of return. I would argue that who was elected was somewhat irrelevant from a general market perspective. The volatility and rate return would have certainly been different but the certainty of knowing who was President is part of what moved the markets forward.
Right now the markets are reacting to the reality of the risk of a possible inflationary environment and the increase in interest rates. My thought is investments is a risk vs. reward game. If interest rates go up, investors will have to take less risk to get a guaranteed rate of return. A simple example, if interest rates go up substantially, you would possibly be able to go to the bank and get a 4% CD rate (we all remember those days). So, as an investor, if you were to take more risk, then you would expect a long term return of more than 4%. Those returns may not be guaranteed and will certainly fluctuate in the short term, but investors would expect to get better long term returns in a higher interest rate environment.
Lastly, we need to consider your personal asset allocation and your diversification. We always talk about risk tolerance, or how comfortable you are with the ups and downs of the market. From there our goal is to allocate your accounts in to a mix of investments that you can be comfortable holding through the volatility of the stock market. That mix of investments can include; United States stocks, global stocks, US bonds, global bonds, savings, CDs, cash, insurance products, among other things. Through that mix of investments we create a diversified portfolio with a risk tolerance that may help you stay invested for your goals through volatile times.*
In conclusion, markets are as hard to predict as the weather. We have some tools that can help us ‘guess’ but different tools are going to give us different ‘guesses’. From the economists and economic indicators I read, we are probably due for some rain showers. We aren’t exactly sure what time of day those showers will roll through and there is a chance they may turn in to a thunderstorm but the forecast says sun should come out when it’s over.
*Diversification/Asset Allocation does not ensure a profit or guarantee against loss.
1 https://www.equities.com/news/historical-look-at-market-corrections
2Source: Standard & Poor’s Corp. and /www.yardeni.com/pub/sp500corrbear.pdf
3 http://money.cnn.com/2016/11/09/investing/dow-jones-trump-wins-election/index.html