After four long years the stock market finally experienced a sell-off worthy of the moniker - Correction. By the close of business yesterday all major averages had dropped in excess of 10% from their respective 52 week highs. We typically refer to a 10% sell-off as a correction and a 20% or greater decline as a bear market. The official category of this decline is yet to be determined.
Why the Sell-Off?
The answer to that question depends on what you read, watch or listen to and what you want it to be. Some blame it on an economic slowdown in China and a possible spillover effect to other regions of the globe. For others it is due to the stock market being potentially over-valued. Yet others attribute it to the deflationary impact of falling oil prices. Finally, some think it is due to concerns over the Federal Reserve's much anticipated, yet undelivered, interest rate increase. Most likely, it is a combination of all of those factors and others, but the truth is no one really knows and it actually doesn't matter. The markets are going to do what they are going to do and none of us can "consistently" predict these inflection points, nor should we attempt to do so. Nor should we hire anyone who would have us believe they possess insight that is superior to everyone else.
Our Equity Portfolios
Our broadly diversified equity holdings consist of 80% U.S. companies and 20% international companies. As significant as the world's second largest economy is, China represents less than 1.5% of our equity model. What happens in the USA is much more important to us than what is going on around the globe, so let's take a quick peak at the current environment here at home. U.S. economic fundamentals are sound as evidenced by:
- Continued strength in consumer spending which comprises 70% of the U.S. economy.
- Robust housing and auto sales that still have a lot of room for improvement.
- Household balance sheets have been repaired and bank credit lending is recovering nicely.
- Interest rates are still at historic lows which bodes well for borrowers.
- Weekly unemployment claims are at a record low and the non-manufacturing PMI index (service sector) is at 60.3, a very bullish economic indicator.
- There are a lot more consumers of petroleum products than producers of those products, so $40 oil is a net positive from a macro-economic perspective.
- Second quarter GDP, which came in at 2.3%, will be revised later this week and some economists think it may be closer to 3%.
I could go on, but I think you get the picture. In spite of the doom and gloom news media, things are not nearly as bad as they would have you believe. Yesterday while driving I heard a radio host say he doesn't trust the stock market and he only owns great companies like Johnson and Johnson, etc. What does he think the stock market is, if not a collection of the greatest companies in the world?
Our Bond Holdings
For those who question the wisdom of owning low-yielding bonds, the current stock market decline should provide the obvious answer. With a few exceptions for our most aggressive clients, we own bonds to temper the volatility of an otherwise all-stock portfolio. Return expectations are lower once we add bonds to the mix but I know few people who can tolerate the inherent volatility of an all-stock portfolio. Given enough time, many investors will capitulate when things look the worst and head to the safety of cash which is often at or near a market bottom. Unless they have some type of fail-safe mechanism in place (i.e. bonds) it is almost impossible to resist the self-preservation instinct that is hard-wired into our brains. We don't like the low interest rates bonds produce either, but we sure want to stay the course on our investment journey.
For anyone who is overly anxious about the current market environment I have a few suggestions.
1. Turn off the noise. The news media sells sensationalism and nothing sells like bad news. If you clutter your mind with constant negative thinking it will surely produce negative fruit. Instead, focus on your blessings, and for most of us when we start counting our blessings it soon puts any negative experience in a proper perspective.
2. Remember the long term nature of owning companies. Many people may not be aware that the stock market has experienced a 10% (or greater) correction, on average, once per year going back to 1929. Because we had not had even a 10% correction since August, 2011 this one should come as no surprise. I admit it is hard to think long-term when we live in the present, but it is imperative to your ability to stay the course.
3. Give us a call and let's talk about it. Even better, let's schedule a time to review your plan (by telephone or in person). Your plan includes the process we use to recommend an asset allocation that increases the likelihood that you will be able to achieve your goals, but with reduced risk. If you don't have a plan consider working with us to create one for you. There is no additional charge and if you are not utilizing our planning services, you are not taking advantage of the full range of resources we make available to each of our clients.
No one knows if the next major move in the market will be up or down. One thing I know for certain is that market declines are an inherent part of owning great companies. Markets also recover. As always, we remain humbled by those of you who entrust to us the planning and management of your financial resources. We do not take it lightly and appreciate your business, trust and confidence.