Last Friday was one of those days in the stock market that makes headlines. As we are writing this on Monday morning, it appears that today will be similar. On Friday the overall U.S. indices moved lower by about 3% with the Dow Jones Industrial Average down 530 points. The index is now around 10% below its high in May.
IWe understand this is concerning. During the past six years every correction immediately brings to mind the pain of the bear market we experienced in 2008 and 2009. However, no two corrections are the same. This year we talked about expecting a 10% correction sometime in 2015, depending on how the markets react to higher interest rates. It does not appear that this recent market volatility is directly linked to interest rates, but volatility has certainly returned to the markets. Sometimes it doesn’t feel very good to be right about market activity.
There are a few questions that seem to be on clients’ minds:
What is causing this correction?
The short answer is that growth in China is slowing and energy markets have corrected. China slowing equates to global economic growth slowing down because they have been the biggest contributor to global growth.
The longer answer is that it has been about four years since the market experienced a 10% correction. U.S. stocks are fully valued, meaning that prices are on the higher side but they do not appear overvalued. When stock values are high, evidence of slowing growth can create a significant market reaction. A market selloff can also prompt more selling as individuals emotionally react. Selling begets selling. However, after a few decent years in the market we see this as a fairly normal correction.
How bad is this going to get? / Are we in a bear market?
No one knows. However, we do not anticipate this becoming a full-blown bear market. Things could get worse, but the things that have led to strong market performance and an improving U.S. economy are still in place. Interest rates are still very low, capital is still cheap and U.S. companies still have more cash on hand than ever in history. In addition, our economy continues to show steady improvement and lower energy prices are in general good for the long-term health of our economy. Consumers and corporations will save money that they have been using for gas or other forms of energy and will be able to redeploy that cash to other spending.
We believe this pullback may look like the correction from 2011. That pullback was almost 20% top to bottom and was driven by concerns in Europe, the downgrade of U.S. government bonds and a looming government shutdown. As those fears subsided, markets quickly regained half their losses and 2012, 2013 and 2014 all ended up being good years for U.S. stocks.
Another thing to keep in mind is that if you are going to invest for the next 20 years, you may see another 10 corrections of this magnitude. In fact the average decline inside one year is over 14%. Corrections are a normal part of the market. They never feel good and no one likes them, but volatility is the price we pay as investors. In exchange, we receive returns that have historically been compelling over long periods of time.
What should we be doing?
Our defined risk approach triggered selling of international stocks on Thursday and U.S. stocks on Friday last week in our managed accounts. We will look to re-enter stocks once volatility subsides and the market price trades above its trailing 200-day average. This is a simple risk aversion process designed to limit exceptionally large losses, not to be confused with a market timing process seeking to make money on declines. We are also looking to harvest some losses in taxable accounts.
We will take advantage of opportunities created by this turmoil. Some energy and technology companies may become excellent buys and we are making adjustments to the bond side as well.
Bottom Line: We know that this is a challenging market environment. Monday August 24th, 2015, may set records as a difficult day. We will keep you informed as to what we see and think about this difficult market.Feel free to contact us if you have questions or would like to discuss your specific portfolio.
We appreciate the continued confidence and the opportunity to serve you & your family.
The views are those of Lyn Adams and should not be construed as investment advice. Registered representative offering securities and advisory services through Cetera Advisor Networks, LLC, Member FINRA / SIPC. Past performance is no guarantee of future results. Investments in securities are not FDIC insured, and may lose value. All information contained herein gathered from sources deemed to be reliable. For more complete information, please see your official statement. It is important that you do not use e-mail to instruct any Cetera Advisor Networks representative/agent to authorize or effect any transaction involving a security, commodity, or insurance product.
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