Even the most experienced investors have felt unnerved by the recent market sell-off. To help calm nerves and foster a long term perspective, here are our answers to some recently asked questions.
Is the recent market decline the start of another major bear market? Many of the world’s stock markets are already in bear market territory which is generally defined as a decline of 20% or more from recent highs. While the S&P 500’s 13% decline looks pretty good against this backdrop, the broad U.S. market has seen a steeper sell off.
We don’t have a crystal ball, but we don’t think a prolonged and deep downturn is likely. Since 1926, the S&P 500 has witnessed 10 bear markets. In eight of these cases, the economy was in recession and in five, stocks were richly priced. A recession does not seem likely at this point (see below) and valuation levels, particularly after the recent downturn, are not extreme.
So, is a U.S. recession likely? Recessions are notoriously difficult to forecast but we don’t see one on the horizon today. To be sure, there are soft spots; weak oil prices and the strong dollar are weighing on industrial production and productivity measures seem stuck in low gear. But a number of offsetting factors should support modest growth going forward. Jobless claims are at low levels (see chart below) and wage gains solid. Housing and auto sales are humming along and the large decline in energy prices should fuel healthy consumer spending as we move through 2016. Finally, government spending at both the federal and local level should provide a tailwind. Any deterioration in employment and wage data might change our opinion but for now, the all important U.S. consumer looks pretty healthy.
If the U.S. economy is in relatively good shape, why are markets in such disarray? Financial markets hate uncertainty and there is plenty of that to go around today. The decline in global energy prices, while a net benefit for much of the world, is upending long standing political and economic relationships. China’s economy is clearly slowing and no one really knows by how much. Here at home, a possible shift to more populist politics and Federal Reserve policy has everyone guessing. The appeal of safe-haven assets in this uncertain environment has sent stock prices and interest rates down and widened credit spreads. Expect volatility to remain until some of these issues are resolved.
What about interest rates? As a result of all this uncertainty, investors are now expecting no more than one rate increase this year. This “lower for longer” assumption could help support stock prices as those with cash, once again, turn to equities as the best of a bad bunch.
What should I do? Large market movements cause portfolio weightings to move off target levels. Rebalancing back to established targets is exactly the kind of buy low, sell high approach that fuels returns.
There may be other good reasons to adjust your investment approach but shifting allocations in reaction to market movements is rarely a winning strategy. Why? In order to be profitable, investors need to get two decisions right: when to sell and when to buy back in. For the vast majority, reinvesting at market lows just when stocks appear most unattractive is too emotionally difficult. Most investors are far more likely to buy back in “when stocks look good” (i.e., when they have already gone up in price). Our recommendation is the emotionally difficult approach (see page 1) of sticking to a well-thought out investment strategy through market ups and downs.