We’re off to a rough start in 2016. Actually, we’re looking at a continuation of events that developed in 2015 but news outlets like to talk about “the worst start to the year in history” rather than admit it’s just a point in time that happens to coincide with the beginning of a new year.
Why are the markets under pressure these days? The drop in oil prices has caused selling across many asset classes as investors have become more conservative. Lower prices also cause capital spending to be put on hold as projects no longer look profitable. Additionally, the debt of many energy companies is at risk as lower cash flows make debt service more difficult. This in turn puts pressure on other non-energy fixed income products.
China is another concern. The world’s second-largest economy is under a lot of pressure these days. They’re facing a nasty bear market and the country’s growth, upon which many emerging and developed economies rely, has slowed. Many worry that Chinese economic data is opaque and that things could be much worse than officials are willing to admit. The most recent data we do have indicates that China is growing at its slowest rate since 2009.
Here in the U.S., the incredibly strong U.S. Dollar isn’t helping either. Around 30% of revenues for S&P 500 companies come from overseas and are negatively affected as the USD continues to rise.
Lastly, there’s the Fed. We saw good employment numbers last week signaling an improving U.S. economy. Expectations are for multiple, though not excessive, Fed rate hikes in 2016. Investors worry that the rate hikes could create too much of a drag on an increasingly delicate economy.
So, with all this going on, it’s no wonder we’ve seen substantial global selling in the past few weeks. If market sentiment continues in its current direction then we’ll most likely end up in a bear market. We may be in one already.
While some of the major U.S. indexes are down only a moderate amount, it’s important to understand that many times, only a handful of stocks are responsible for a large amount of index performance. At this point, many investors have individual stocks that are down quite a bit more than index levels. Around half of all S&P 500 stocks are down 20% or more from their highs so it’s no surprise that investors are feeling some pain.
We would like to point out that bear markets happen all the time. They are a natural part of the investment process. For many of us, 2008 and 2009 are still very fresh memories but it’s critical to understand that every bear market doesn’t end in a crash and/or a recession. Also, equity markets and economic growth are not closely correlated in the shorter term. Over decades-long periods we certainly see some correlation but bear markets can happen during an economic expansion.
We are always going to have bull and bear markets. The financial markets have their ups and downs just like everything in life. Instead of knee-jerk reactions to changing markets, the only way we see to be successful in the long-term is to have a solid financial plan and stick to it.
The purpose of a good financial plan is to develop a roadmap to help you achieve your short and long-term financial goals. It’s a benchmark to help keep you on the right track especially during challenging market conditions. More importantly, it helps you decide how much risk you actually need to take. We sometimes find that investors are taking more risk than is probably needed to achieve their goals.
We consider financial planning to be integral to our overall asset management process. It’s critical for us to understand things like your retirement income plan and asset protection strategies. As such, we don’t charge any extra fees for financial planning. It’s included as a free service to all clients.
It’s also critical to manage our emotions. As prices move up it becomes easier to think they’ll keep going up and as prices go down, like we’ve experienced recently, it’s natural to expect them to continue in that direction. But at some point we get a reversal that nobody sees coming and the investment landscape changes again.
Many investors find bear markets to be a psychological challenge. We are not immune to the concerns that volatile markets create and we certainly have the same worries that other investors have. For some people, this may be a good time to re-evaluate their tolerance of a bear market. We certainly don’t advocate exiting stocks completely but, depending on your specific situation, this could be a good time to look at adding some cash and high quality bonds to portfolios in an effort to dampen volatility.
One research piece we’ve recently come across noted that bullish sentiment is below 20% these days. This is a pretty low historical level. We get to these points sometimes but if you look at what happens in the coming months after we reach these levels, it’s not uncommon to see more favorable market conditions in the following months and years.
Perhaps the most maddening thing about investing is that we never know whether we’ve made the correct decisions until months or years later. In the shorter term, investing is often driven by fear and greed which makes it almost impossible to truly know exactly where we are in any given market cycle.
We may be completely wrong about this but it doesn’t appear to us that we’re on the edge of a market collapse. We probably still have some rough times ahead but this looks like the kind of volatility that is completely normal for any equity investor. Unfortunately, we can’t make it less painful. The way to get through these periods is to have a well-diversified portfolio and a solid financial plan to keep us on track.
Financial planning is a dynamic process. Our lives and situations change and so we’re always happy to adjust our recommendations to your situation. If you feel uneasy about current market conditions, feel free to give us a call. We’re always here to help.
Takeaways
1. We’re in a difficult market and while these situations never feel very good, they are a normal part of the investment cycle. Markets don’t go up continuously. They get overvalued and pull back. We don’t know the future but not all bear markets end in a market crash or economic depression.
2. One of the critical things a good financial plan does is set up a roadmap for your financial journey. Your portfolio acts as the road that you travel from point A to point B. The plan you create becomes your navigation system; as you work through the development of your plan, you identify and establish guard rails along the road. These are critical risk reduction and risk transference aspects of your overall plan. Taking this approach not only helps keep emotions in check along the journey, they help us reach our final destination.
Jeff and Shelby
P.S. In a few days we’ll be sending out a tool to help you evaluate your risk tolerance. Obviously this isn’t an exact science but this particular tool has been helpful to some clients with regard to getting a better feel for how to best structure their portfolio in relation to much risk they can take.
Sources:
“On My Radar: A Cyclical Bear Market (Here’s Why)” Steve Blumenthal January 15th 2016 http://www.cmgwealth.com/ri/8062-2/
“Running of the Bears” Bespoke Investment Group B.I.G. Tips January 14th 2016
“Why the Heck Are the Markets Tanking” Yahoo Finance 2016 http://finance.yahoo.com/news/why-the-heck-are-the-markets-tanking-165146322.html
“If You’re Reading This It’s Not Too Late” Josh Brown, The Reformed Broker January 15th 2016 http://thereformedbroker.com/2016/01/15/if-youre-reading-this-its-not-too-late/
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