In the midst of the stock market’s record bad start to the year, on January 21st we sent the following note by e-mail to clients of C.H. Douglas & Gray Wealth Management. Since its low on the 20th of January, the S&P 500 is now up over 10%, having recovered fully from its January losses and entered positive territory for the year. Though the market may yet correct downward again before the year is out, the decline and the recovery during the first quarter present a good object lesson for maintaining discipline through market turbulence in an appropriately diversified and risk-adjusted portfolio.
Turmoil in the Markets
The stock markets globally are going through a moment of turmoil. In our opinion, there are two primary related reasons for this present turmoil.
The first reason is fear that the global economy may be slowing, especially given concerns that the development of China, which has contributed much to global growth, may no longer have so much to contribute. The damage of a slow-down in China is felt especially on commodities, like copper, steel, iron, and oil, all of which are supplied by the rest of the world to China. If China won’t be buying as much, then producers of commodities won’t be able to sell as much, nor will companies that supply those producers with the equipment necessary to produce them. So a slowdown can hurt even American manufacturers like Caterpillar, which supplied so much to construction in China and to mining in many other countries. As you can see, a slow-down in China can ripple through the global economy even to jobs in America.
The second and related reason is the drop in the price of oil. The price of oil is dropping because if the global economy is slowing, then less oil is required, especially if we have increasing fuel efficiency and alternatives to oil like wind and solar power. But at the same time that we have less need for oil, we have more of it, because the United States has been so effective at developing our own oil supply. And more still may enter the market from Iran, which finally is re-entering the global economy with oil as its main contribution. The problem with the massive drop in the price of oil is that it means a drop in revenue for oil companies, especially those that have invested so heavily in fracking, which has contributed so much to economic growth in America. So corporate profits are taking a hit.
What we have described are global growing pains that all acknowledge. There are others that are politically sensitive… that cause arguments around dinner tables… and so we won’t address them here, except to say that how governments around the world address their economies does influence the future. In America, these policies are the product of a democratic process, and 2016 is an election year, so this adds to economic uncertainty.
All of these things said, how would we advise investors to react?
The first is to recognize that over the long term, the average investor often does significantly worse than the market. The reason is that it is only after the markets have done well that the average investor too often starts buying. By then prices may be too high. Then, only after the markets have fallen, does the average investor start to sell. By then prices may be attractive. Consequently, the average investor is often enthusiastically buying at the wrong time and anxiously selling at exactly the wrong time. Studies now show that sophisticated investors have done well over the last decade and a half compared to unsophisticated investors because of this very reason, having recovered their losses both from the year 2000 and from 2008 while the average investor was abandoning stocks. When the market is in its worst position is also when the market is at its most attractive. So, though the market may yet have some downside, this is likely the wrong time to be selling. Those with money on the sidelines with eyes focused on the long term more likely ought to be considering buying.
The second is to know that there is not just downside risk, but upside risk as well, that is, missing out when markets swing upwards. We just don’t know what Central Banks are going to do. For example, this morning the European Central bank announced measures to introduce more and cheaper money into Europe’s economy, and so stocks there have rallied. If the U.S. economy seems to be losing its footing, the Federal Reserve too could announce its intention to delay increases in interest rates, or even lower them into negative territory, as European central banks have. Either could cause a rally in stocks. And so it seems unwise to bet that stock markets will fall further. By the end of the year, optimism could reign again, and though the markets are down now, it is not at all clear that they will remain so. We don’t know. (And those who say they know also don’t know!)
So for investors who are younger, it is important to recognize that drops in the market provide opportunity to invest at lower prices with a better opportunity therefore to improve long term returns. It is counter-intuitive, but drops in the stock market are very good for you.
For older investors, it is important to have been reducing exposure to stocks all along, precisely so as to avoid the pain associated with stock drops from which you might not have sufficient time to recover. Admittedly, this can be a scary time for older investors, for cash is earning nothing, and bonds offer little return and could even lose money, though not as much as stocks can. Provided that you are not over-exposed to stocks, it may be helpful to know that if you are able to maintain discipline and rebalance through turmoil, once the turmoil has passed you can be in a better position than if the turmoil hadn’t even occurred. (Rebalancing is that process of selling some of that which has done well and buying some of that which has done poorly in order to maintain a target allocation between the assets.)
It is in the midst of market turmoil that some truly poor investment decisions can be made. The best decision making takes place in advance, by considering your ability to take risk and endure the ups and downs of the stock market, and then positioning your investments accordingly in a well-diversified portfolio. Then, when turmoil strikes, there is seldom a wiser policy than to maintain discipline and rebalance.
In the meantime, please do not hesitate to give us a call at 317-843-8300 if you would like to discuss your portfolio.
The thoughts expressed on this web page provide insight into the investment and/or financial planning considerations of members of C.H. Douglas & Gray, LLC, a firm providing fee-only financial advice in asset management to households and institutions in states in which it is registered. Specific investment advice is available only to clients of the firm. Contact C.H. Douglas & Gray for more information.