Last week, the US stock markets experienced a sharp decline with the S&P 500 index* down 5.8% for the week, bringing it down 7.5% from its intra-year high. As usual, many investors turn to panic when they see the headlines about the volatile stock market. Some wonder if we are about to see another market crash like we did in 2008. Of course, no one can predict what will happen as the markets are NOT rational markets, mostly because they are affected by the actions of irrational people. However, we would like to mention a few points to put things into perspective.
- We are now in the seventh year of a bull market. This is the third longest bull market we have seen since the Great Depression. It should not be surprising to us to see the market correct itself. This is a completely normal part of market cycles and one that we have seen over and over again in our 30 years in business.
- Intra-year declines are not uncommon. In fact, it has been 20 years since we have seen a year that did NOT have an intra-year decline of more than 5%. So even with all of the positive years we have seen in the stock market over the past seven years, each one of them had their own period of at least a 5% decrease. You can see this on the next slide from JP Morgan which compares intra-year declines vs. calendar year returns on the S&P 500.
The gray bars represent the annual return by the end of the year and the red dots represent how much the market had been down at some point during that year. Take 2012 for example. That year the market was down 10% at one point during the year but ended up 13% by the end of the year. Of course, past performance never guarantees future results. We are just making the point that these intra-year declines are normal.
- Bear Market not likely. Since the bear market of 2008 is still fresh in the minds of many investors, it is easy to wonder if this latest drop in the markets are indicative of another bear market coming. Keep in mind that a bear market is defined as a 20% or more decline from the previous market high. Once again, we can never predict what is coming. However, it helps to look back at the ten bear markets we have had since the crash of 1929 to look for anything they have in common.
This chart from JP Morgan shows that bear markets are typically accompanied by either a recession, a spike in commodity prices, aggressive Fed tightening, or extreme valuations. Currently, we are not experiencing any of these characteristics. In contrast, our economy is relatively stable, commodity prices are low, interest rates have remained low for many years, and while stocks are moderately over-valued, their valuations are not at extreme levels like we saw before the tech bubble crash in 2000. Because of these factors, among others, we do not feel we are in the beginning stages of a bear market.
- Panic is not a strategy. When you established your investment portfolio allocations and financial strategy, it was based on your time horizon, objectives, and risk tolerance, and not necessarily on what the markets were doing at any given time. When your objective is long term, the plan should not necessarily change just because of short-term volatility in the stock market. It feels hard to “do nothing” in times like these but it is often the best way to keep yourself from making the mistake of allowing emotions to overrule your logic.
*Indexes cannot be invested in directly, are unmanaged and do not incur management fees, costs or expenses. Investing in securities involves risk, including the potential loss of principal invested.
*No investment strategy can guarantee a profit or protect against loss. Past performance is not indicative of future results. Although the information has been gathered from sources believed to be reliable, it cannot be guaranteed. This material may contain forward looking statements and projections. There are no guarantees that these results will be achieved. It is our goal to help investors by identifying changing market conditions, however, investors should be aware that no investment advisor can accurately predict all of the changes that may occur in the economy or the stock market.
