For the first time in almost 2 years, the stock market demonstrated a small sell-off over the last week. We have been proactive over the past 6 months to remind all our clients that it is NOT normal for the market to go up every month of the year. In fact, 2017 turned out to be the first year ever recorded in the U.S. market where the value went up each month. With such a recent run-up in stocks, what might normal volatility feel like in 2018?
Large numbers don't mean large %'s. Now that the Dow is priced in the upper 20,000's, it is important to realize that a 500-600 point move does not mean what it used to. Many of us have been investing for long enough that we grew accustom to a 500-600 point move meant a 5-8% loss (like back in the 2008 recession when the Dow was between 6,700 and 10,000.) From an investment perspective, last Friday's Dow selloff of 665 points represents a loss of just over 2% for those 30 stocks.
Repricing a new paradigm is a volatile process. The implications of the new tax law on future corporate earnings are vast. The price that investors are willing to pay for stocks today is a multiple of future earnings. Wall Street understands that corporations will have noticeably higher after tax profits with the new law, but analysts' jobs of calculating exactly what earnings will become is a near impossible task.
It will become clearer what earnings will grow to in time, but the stock market is trying to make educated guesses now, and price stocks today based on these guesses. As new considerations become known for various industry groups, earnings assumptions will change. At this moment, stock prices reflect much of the positive implications from the tax law. However, we should expect that any surprises should cause normal short term volatility.
Expect media to make it scary. One other characteristic about volatility to expect is that media tends to drive fear. The media business is about obtaining viewership. As such, remember that news outlets often over-sensationalize normal volatility to get more viewers. Tenured long-term investors tend to be more immune to this, but there are currently a large population of investors in 2018 that don't have the experience gained from managing regular stock market volatility for the past 2 decades. With a stock market that has been steadily climbing for 8.5 years, not everyone remembers how the media works when we get short term market sell-offs.
BOTTOM LINE: Market volatility is a normal part of investing. 29 of the past 38 years have been positive for the US stock market, despite the fact that the average intra-year price drop is -13.8%*. It's important to stay focused on your long term investment goals and trust your investment management process when volatility picks up.