How does today’s volatile stock market make you feel? If you are paying attention to the headlines, I’m guessing you feel a little uneasy at best. Here is one of many questions we ask a lot of our new clients: If the market were to experience a 10% decline, how would it affect your strategy or behavior? In such a hypothetical scenario as it is presented, everyone knows the right answer is to buy low and sell high. Putting yourself in such a moment isn’t easy for anyone. It is difficult to mentally generate the pain of a 10% correction without actually experiencing it.
The truth is, 10% corrections happen regularly, about once per year on average. The average annual peak-to-trough pullback in the S&P 500 is roughly 14% going back to 1980. Since bottoming out in 2009, the S&P 500 has experienced drops of 28%, 19%, 16% now twice, 12%, 11%, and 10% twice. In the same time period, the market has not experienced a negative calendar year until 2018, and it has quadrupled in value.1 Volatility is normal. Frankly, the market can’t function without it.
One of the most famous investment quotes of all-time is by Sir John Templeton. “Bull markets are born on pessimism, grow on skepticism, mature on optimism, and die on euphoria.” Over long-term market cycles, investors are naturally most afraid during the best times to invest, and the most confident during the worst times to invest. As Warren Buffet once said, “Be fearful when others are greedy and greedy when others are fearful.”
No doubt, the fourth quarter of 2018 was ugly. Volatility has reared its ugly head, sparking memories of the financial crisis of 2008. Investor confidence has deteriorated. Funds are flowing from stocks to bonds and cash in what appears to be a flight to safety. There is currently over $16 Trillion in cash accounts in the U.S. As of the time this was written, the market cap of the entire S&P 500 Index is only $23.8 Trillion.2 If I had to peg this market somewhere according to Sir John Templeton’s scale, I’d put us squarely in the “skepticism” range.
“But it’s different this time!” No. It really isn’t. There is and always will be something for the media to point to so they can get your attention and generate clicks and views. That is their job, after all. When I sort all of this out, it looks more and more like most corrections – a snap emotional reaction with building momentum amidst reasonably strong fundamentals and growth potential. The latter are the facts that really matter.
So maybe you’re a little more comfortable with the “feeling” part. Here are a few of today’s headline concerns, along with our viewpoints:
- What if the Fed is raising rates too fast?
If you look at the last 5 times the Fed has raised the Fed Funds rate, and I’m just eyeballing the chart here, they are raising rates at about ½ the pace they typically do. 4 rate hikes of .25% over the course of a year is only 1% per year. It is certainly nothing to be overly concerned about, particularly if the economics looks strong. If we want a strong economy, rising rates is part of the equation.
- What if these tariffs lead to a trade war with China?
For a little perspective on what the tariffs actually mean to our economy, the worst-case tariff impact could be about $143 Billion. Projected global GDP growth for the year is over $5 Trillion.3 We are talking about a rounding error here. In China Specifically, it may be a different story, which leads me to believe that they are all the more motivated to get a deal done. The concern is how long they are willing to wait and suffer the economic consequences. If they are willing to wait until the 2020 election, this worry could continue. If and when we see progress toward a resolution, we expect equities, particularly on the international side, to bounce back rather quickly.
- The government is a mess. What does a shutdown mean? What if the President is impeached?
Did you know that Proctor & Gamble sold over $21 billion in their Fabric and Home Care segment last year?4 JPMorgan Chase serves over 61 million U.S. households with consumer and community banking services.5 Amazon is on track to clear $258 billion in U.S. retail sales in 20186, and they sell… well, they sell everything. We are invested in laundry detergent. We are invested in banking. We are invested in tires, data streaming, shoes, and sure, iPads and electric cars too. We are invested in capitalism, innovation, and productivity – not the government.
The government has shut down 20 times in the last 50 years.7 Typically, we see a market reaction up front but minimal impact if any when it is all said and done.8 If the president is impeached, it is unlikely he is actually removed. If he is removed, then there will be another president with a similar agenda who won’t tweet as much and half the population will be critical of him. I think the market will be ok.
Speaking of those company earnings we are invested in – the S&P 500 is back down to a P/E ratio of 14.49, which is the most attractive level we have seen in a while. In a year when S&P 500 earnings grew by 28%10 and prices went down, it has opened up what we believe is a really nice buying opportunity for the long-term investor. Is it a good opportunity in the short-term? Who knows? As responsible stewards of wealth, we don’t use short-term strategies to address long-term goals.
The best way to be a successful long-term investor is to get comfortable in uncomfortable markets. Don’t get me wrong, you should always be comfortable with the risk level of your portfolio. But if your stock investment strategy is to wait until we have what you perceive to be a “comfortable” market, you’ll be buying in at higher prices. We’ve never had more calls and questions than we did in 2008 – and look what the market has done since then.
If investing in stocks was easy, stocks wouldn’t be stocks – they would be bonds. The toughest part of investing is tuning out the noise and mentally weathering the storm. As I’ve said before, our industry is the only one in which everyone’s inclination is to run for the hills when our products are on sale.
1JP Morgan Guide to the Markets, December 31, 2018, page 14
2JP Morgan Guide to the Markets, December 31, 2018, page 66; https://ycharts.com/indicators/sandp_500_market_cap
3International Monetary Fund (IMF), as of 7/30/2018. GDP forecast (USD). 2018 estimate based on the IMF’s October 2017 World Economic Outlook global nominal GDP growth and calculated growth projection of 6.4%. Worst-case tariff impact from the Office of US Trade Representative, China Ministry of Commerce, the American Action Forum, CNN, Politico and the Peterson Institute for International Economics, 8/23/2018
9JP Morgan Guide to the Markets, December 31, 2018, page 4; page 8
10Earnings growth based on year-over-year third quarter estimates:
S&P 500 Index is considered a reflection of the large capitalization U.S. stock market. It is the benchmark against which judging the overall performance of money management is used. It is not possible to invest directly in any index. Past performance is not indicative of future results.
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