Which is it? If you listen to many of the “experts” who expect the market to drop, they project a decline of anywhere from 40% to as much as 80%. There are other experts who believe the market will consolidate and end up 8% to 10% for the year. We are in the market consolidation camp. To explain why, let’s put things in their proper perspective.
1) We have just participated in the best bull market ever. From the lows of 2009 to the high in October 2015 the S&P 500 advanced almost 200% or 17% per year. It recorded these gains with only one significant pullback which occurred in 2011. It is unusual for the market to perform for such a long period in this manner without consolidation or corrections along the way. While market corrections are defined by 10% to 15% declines, this correction could be greater due to the exceptional advances over the past six years. A correction of this magnitude would not be unusual.
2) Market declines of 30% or greater are always accompanied by an economic recession. While the economy is growing slower than previous recoveries, most economists are not projecting a recession.
3) Some say that interest rates will rise due to the Fed’s tightening. So far, after the first round of tightening, interest rates are lower. As we have said in previous letters, we do not believe interest rates will rise in the near-term.
4) What about all of the problems we are seeing? Should we be concerned about the effect on the U. S. economy of international issues such as China’s economic slowdown, the oil price decline, tension in the Middle East, ISIS on the march, and North Korea’s nuclear test? There are always international issues of one kind or another. The U. S. economy and the stock market have been through problem times more severe than these and have come through them and gone on to new highs. Historically, betting against the U. S. economy has not been a winning strategy.
5) Where can you invest your money? Your choices have always been stocks, bonds, or cash. In the current environment, bonds pay almost nothing (10 year U. S Treasuries yield 2.11%), cash yields zero percent and the stock market (S&P 500) yields 2.5%. Today, stocks yield more than quality bonds.
6) In the period from December 31, 1980 to December 31, 2015 the annualized return for the S&P 500 was 10.95%, which demonstrates the long-term viability of the U. S. stock market.
7) From the peak of the market in April 2000 to December 2015, the market advanced 5.65%. This is not an impressive number by itself until you realize this was also a period that experienced two severe market downturns of over 50% each (the dot.com crisis and the financial crisis).
8) As much as we would like the market to go up a smooth 7% to 11% each and every year, that is not the case. If that were the case, we would not need to own bonds or have a savings account. We could simply invest in the stock market and sell whenever we needed cash. Unfortunately, investing doesn’t work that way. In order to earn the higher returns from stocks we must absorb and weather the market volatility.
9) History has shown that patient investors, those who don’t have a knee-jerk reaction to every volatile period in the market, have more success than those who do.
10) Bottom line: We believe this market is going through a correction and consolidation phase that may have more downside but not enough to make any drastic changes in your asset allocation. Remember, dividends are an important component of your portfolio. While the market may fluctuate, corporate dividends tend to go up the majority of time.
While we know it is discomforting for you to see your portfolio fluctuate, it is our job to see that our clients do not panic and react to every sharp move up or down. Believe me, financial advisors have many sleepless nights when we have these volatile markets. After many years in this profession I know there are things we can control in our business and things we just cannot. We cannot control the economy or the stock market, so we turn our attentions to the things we can manage. If the market declines further we will be presented with an opportunity to buy some great companies with solid dividends and dividend growth at bargain prices.