Stocks on Sale

U.S. stocks have already seen two pullbacks greater than 5% so far in 2018, as measured by the S&P 500 Index. That compares to only one pullback over 5% in the last 2 years. To say that recent stock swings have been jarring would be an understatement. While sharp declines in prices are unpleasant, equity volatility has been unusually low since the Financial Crisis ended in 2009. Unprecedented support from the Federal Reserve coupled with steady economic growth has pushed stocks steadily higher for 9 years.

As a result, investors have gotten used to smooth and steady stock market gains. But our experience since 2009, in which the S&P 500 Index declined 5% or more only 10 times, is not the norm. Going back to 1945, on average the S&P 500 Index has experienced declines of 5% or more every six months – almost double the frequency of pullbacks we’ve had since the Financial Crisis. While the recent past has been a pleasant ride, market volatility is likely to increase going forward, which may not be a bad thing.

A friend of mine and savvy stock investor once told me that she loved market pullbacks. “It’s like a sale,” she said, “…an opportunity to buy quality products at discounted prices!” Her analogy stuck with me over the years and today I view market pullbacks as opportunities rather than a reason to panic.  Granted, training my brain to think this way took some time and effort. But as an investor, it is an endeavor worth pursuing.

Consulting firm, Dalbar, provides an excellent reason to re-frame your thinking regarding market pullbacks. According to their research, while the S&P 500 Index has delivered an annualized trailing 10-year return of 6.95% through 2016, the average investor return was just 3.64%! Even more striking, the average investor earned a 4% annualized return over the trailing 30-year period compared with the S&P 500 Index’s 10% annualized return for the same period!

As the data clearly indicates and as Dalbar notes, “Investment returns are more dependent on investor behavior than fund performance.” These well-below market returns happen because investors tend to sell their stocks (and bonds) as prices are falling or bottoming. Instead of buying low and selling high – the tried and true way to grow wealth – a lack of investment discipline causes many retail investors to do just the opposite. To compound matters, after selling their stocks and funds during market downturns, many investors – scared from the market turbulence – typically sit on the sidelines as markets recover and therefore never recoup their portfolio losses.

While not all market declines present perfect buying opportunities, falling asset prices do present a chance to add to positions at lower prices. Stocks (and bonds) are on sale! Sometimes downturns are longer and more severe than we would like or expect. However, timing the market is a losing game. Research suggests that taking a long-term approach to investing, regularly rebalancing your portfolio to an appropriate target allocation, and staying invested through market downturns significantly increases the odds that you reach your long-term financial goals.

Weathering market turbulence is not for the faint of heart – which is why a financial advisor can be such a valuable asset. During turbulent market environments your advisor will guide you through market downturns, rebalance your portfolio to take advantage of lower prices, and ultimately remind you why you’re invested. On that note, we’re grateful you’re our client!

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Bear Market Anniversary Reflections

March 9th marked the 9 year anniversary of the most recent bear market bottom. It passed quietly with no bands playing and no flags flying. For those who endured the decline, it was a stressful experience that tested the mettle of all of us as investors. The market peaked in October 2007, and then the S & P 500 index of large-company US stocks fell 37% in 2008. Stocks continued to fall in early 2009, until the market finally bottomed on March 9th.  Overall, there was about a 57% decline in the S & P 500 from peak to trough, the magnitude of which no one had seen since the Great Depression. Although the length of the decline was in line with the post-World War II average for a bear market at 17 months, it seemed like it would never end. After hitting the bottom on March 9, 2009, the market recovered sharply and closed up 26.5% for the year. It is interesting to note that despite these declines, the calendar years 2007 and 2009 were both positive for stocks. All declines, while distressing at the time, have proven temporary.

2017 marked the 9th positive year in a row for stocks. While we remain optimistic about the economy, we recognize that eventually there will be another negative year or years. There’s just no way to predict exactly when these will occur. Fortunately, all the major declines in modern history have been short-lived, typically lasting 2-3 years. In the past 92 years, 1929-32 was the only consecutive 4 year down period for stocks. 1973-74 was a 2 year decline, and 2000-02 was a 3 year decline.

If you don’t know when the declines are going to come, what can an investor do to maximize their chances of success?

Make sure you have an appropriate asset allocation (mix of stocks, bonds and cash) that suits your individual risk tolerance and spending needs. You should keep enough cash to provide for emergencies (we typically recommend 3-12 months of after-tax living expenses) and enough fixed income to serve a source of spending when stock prices are lower. While bonds are not particularly attractive right now with interest rates likely to rise from here, you will be glad you have them to help weather the periodic declines that historically are short-lived.

-Avoid making dramatic changes to your portfolio based on news headlines or the mood of the day.  The sudden “I’ve got a feeling” moves in to or out of the market, with a large portion of your portfolio are what can really hurt investors.

Focus on portfolio income. Dividend income from the stocks in your portfolio should be higher each year since more companies will increase their dividends than cut them. Many S & P 500 companies have histories of consecutive dividend increases of 25 years or more, with some over 60 years.

Understand how much you are spending, including what is discretionary and what is not.  The household spending level is the hardest question for most people to answer as we are updating their financial plans. If you are a Parsec client, take advantage of our eMoney portal to get a better idea of your spending by linking your credit cards and bank accounts. Access to the eMoney portal is included at no additional cost to Parsec clients.

Once you have a good grasp of your expenses, periodically monitor your spending level in relation to your portfolio income and investment assets, and adjust if needed.

Historically, the stock market has many more up years than down years. The key is having an appropriate asset allocation, not making dramatic changes to your portfolio based on the mood of the day, and periodically rebalancing to your target mix (which forces the discipline to buy low and sell high).

 

Bill Hansen, CFA

President and Chief Investment Officer

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