FPH Insights - August 25th, 2015 - Special ReportSubmitted by Financial Planning Hawaii on August 25th, 2015
"The stock market is the only retail setting in the world in which the more prices get marked down, the less people are inclined to buy!" - Nest Egg Guru
I have penned this special edition of FPH Insights to address client concerns that inevitably arise when stock market volatility begins to make news headlines for a few days in a row. The following is not so much commentary on the current environment as it is a collection of insights from nearly three decades of investment experience.
Much fuss has been made by TV financial divas over the stock market decline of the past week. As of this writing, the decline represents a 10% decline from the previous market peak. When the market was at its peak, the same divas were saying it was overpriced. Now they are using words, such as “crash,” “plummet,” “nosedive,” and “freefall.” Learning to tune out such histrionics and hyperbole is a key to becoming a successful long term investor.
A 500 point one-day decline in the stock market was significant when the Dow was at 2000 back in 1987. Today, with the Dow at 16,000, triple-digit one-day declines are far less dramatic as a percentage of the total market value.
In the 26 years that I have been a financial advisor, I have seen the stock market decline more than 20% from a previous high many times. Over the past 50 years there have been five bear markets in which the Dow Jones Indstrial Average declined more than 35% from its previous high [Source: Bear Markets in Modern Times - Motley Fool]. Since 2000, there have been two severe multi-year bear markets. In each bear market the vast majority of companies that comprise the stock market recovered and the markets have gone higher. Investors need to understand that 20-30% declines are relative common-place and that it simply goes with the turf. Expect it and seek ways to profit from it.
If you have a sound, well-diversified portfolio, why panic? There is a mountain of empirical research demonstrating how investors consistently make mistakes by trying to time their entries into and out of the stock market during times of increased volatility. Let’s be smarter than that.
The drivers of the stock market’s current decline appear to be the health of China’s economy and concerns over the Federal Reserve Board’s interest rate policy and mechanism. With respect to China, I don’t think anyone is terribly surprised that its bubble economy is bursting. As the second largest economy on earth, it is rational to conclude that this may adversely impact other countries around the world too. Recessions happen. The larger fear with China (and also with Russia) is that the controlling governments turn to saber rattling and militarism to quell the uprising from their own population (much as North Korea has done). With respect to the Fed, the concern seems to be that the institution used all of its interest lowering power in the 2008-2009 crisis and that its intervention powers to support the U.S. economy the next time around may be limited.
In terms of my guidance, those who contact me for my opinion on the direction of the stock market are forewarned that you may receive a curmudgeonly response. At this point in my career, I consider myself a grizzled veteran. I feel like we have seen this movie too many times before to react with fear. If the recent slide does turn out to be the next bear market, so what? Even through the two long bear markets in the last decade, the stock market reached a new high within five years of the pre-bear market peak. Short of Armageddon, the stock market should rebound, as it has 100% of the time in the past.
I am amazed at how many people talk about looking forward to investing at a time when market prices decline, but get fearful when it actually happens. Market declines do not happen when conditions are rosy.
I am pleased with the way our client portfolios are constructed and believe most clients are well positioned to weather even a prolonged bear market. But what happens if the market doesn’t ever come back this time? – If that happens, my friends, chances are we have larger problems on our hands than the values of our stock portfolios.
“Be fearful when others are greedy and greedy when others are fearful,” is one of Warren Buffett’s most oft-cited pearls of wisdom. Over the past few days, I have a few clients who have called to inquire as to whether it may be time to get greedy. The intestinal fortitude to stand ready to buy when the rest of the herd of investors appear to be heading for the exits is admirable and reflects both investment experience and maturity. However, in my opinion, it is still too early. Despite all the hoopla over the past several days, the market really has not fallen all that much yet. As a general suggestion, I would be inclined to think more about buying in when the decline reaches 20% or so.
I hope at least some of these ramblings are helpful.
The opinions expressed herein are solely those of the author and do not necessarily reflect those of J.W. Cole, Inc. or J.W. Cole advisors (the brokerage/RIA firms with which the author is affiliated).
Readers should be aware that past performance offers no insight into future returns, and that investment in securities entails risk. Market benchmark indices are cited in this piece to provide a frame of reference. However, investors should be aware that one cannot directly invest in an index. None of the information contained in this post should be construed as a recommendation to purchase or sell investments.