As you've probably heard, the stock market has had a very rough start in 2016. The US stock market, as measured by the S&P500 Index, is down about 8% thus far in 2016. I know many of you have two main questions about this, and I'll try to answer them here as simply and concisely as I can. But as always you're welcome to call or email me if you'd like more info or to talk about your portfolio in particular.
Question #1: What is going on??
If you remember, in August-September of last year we had a correction of about 12% (and n the month of October we recovered pretty much all of that decline). This has so far been a very similar correction, driven by some of the same concerns:
- · China continues to show signs of a slowing economy, causing concern over the impact on all of the world's economies.
- · Oil continues to drop, reaching 14-year lows today under $30 per barrel (18 months ago oil was well over $100 per barrel).
- · In the US, our Federal Reserve raised short-term interest rates in December, a move which was widely anticipated but causes concern because higher interest rates can slow economic growth.
All of these are valid concerns, and all have existed for the better part of the past 6-9 months, but markets in the short run can be driven by emotion, running from fear to complacency back to fear in no time (sometimes in one day!).
All of these issues are closely watched and assessed by not only SEI in determining how our investment allocations should be adjusted on the margin, but also by the managers within our portfolios who are deciding which industries and companies should be bought or sold within their fund.
How bad will it get/When will it stop???
First, let's consider how drastic/unusual this type of decline is. Corrections like this have been rare in the past three years, but over the prior 19 years we've had 10% declines at some point during the year 75% of the time. Over the past 36 years we've averaged intra-year declines of 14% but ended with positive returns for the year 75% of the time. So it's very common for markets to go through rough spells, and it often doesn't translate into bad years.
While trying to predict market moves is tough (some would call it a "fool's game"), it's important to look at the fundamentals as we know them today to help us answer the question of what is possible with the stock market.
- · The US stock market by most measures is not overvalued (unlike in 2000 or 2007, when stocks were highly valued by many measures). In an environment where alternative investments (bonds, cash) offer very little return, it's unlikely that stocks would get exceptionally "cheap", a lack of viable investment options in and of itself should support stock prices.
- · Dividend yield on the broad market is again greater than the yield on 10-year Treasury bonds, a condition seen only a handful of times over the past 50 years, generally near market bottoms rather than at market tops.
- · Economic growth in the US, while tepid, is positive, and inflation is non-existent.
- · Corporate balance sheets are in great shape, unlike in 2007-8 when many companies had over-leveraged and unprepared for an economic slowdown.
Given that backdrop, it's hard to make the case for a repeat of the 50% declines we saw in 2000-2 and 2007-9. It's entirely possible we could see another 10% on the downside, which would be quite common (20% declines, "bear markets", historically have happened every 3-5 years). It's also possible that emotions are reaching a peak, and the majority of the decline has already happened. Being a planner, I'd suggest hoping for the latter but mentally preparing for the former.
To translate this possible 20% decline into the impact on a portfolio, in a balanced 60% stock/40% bond portfolio you'd probably see a 12-14% decline. Most all of you have some allocation to bonds, and it's important to remember that bonds typically go up when stocks go down. While we can't prevent the market from having down times (but we all wish we could!), we insulate ourselves from the full force of the swings by owning some bonds. Portfolio Construction 101: Diversify.
Don't hesitate to contact me if I can help with your situation.