We humans are hard-wired to explain events. We always want to know why something has happened and we offer theories about the cause to satisfy our primal need to understand our surroundings.
This is a very common practice in the financial markets; especially when we see market pullbacks like the one we are currently experiencing. Analysts and TV commentators parade across our screens as they scramble to find reasons for the selloff. At present, they blame emerging market worries and QE tapering but we feel it’s important to understand that while these events might be the catalyst for a selloff, they are not, in our opinion, the cause.
The S&P 500 Index started 2010 at a level of about 1115 and ended 2013 at about 1848 which is an increase of approximately 66%. As momentum picked up in 2013, more and more people continued to wonder when the correction would come. After all, trees don’t grow to the sky and corrections are “healthy” for the market.
Of course, saying something like this is as easy as saying you’ll start a new diet right after you’ve eaten a half gallon of ice cream. The actual pullback/correction itself is painful. We’ve gotten used to positive market momentum but there comes a point when some people decide to take profits and/or reduce their risk profile and we see prices fall. This has happened many, many times in the past and it is a very normal part of the investment process. We’ve had a lot of pizza and ice cream in the past few years and now it’s time to hit the gym. The problem is that going to the gym sucks.
So now we have our correction.
At the time this is being written, we see market levels pulling back all the way to where they were in, (gulp) November 2013. Please pass the smelling salts.
The current environment should not worry an investor.
A true investor knows and understands that corrections are an essential part of the investment process. We don’t know what will happen in 2014 but we do feel that there are more positives than negatives:
- Earnings have continued to be strong and so has corporate guidance about plans for expansion and expectations for profits in the year ahead.
- According to First Trust, government spending in the US has fallen from a peak of about 25% of GDP in 2009 to under 21% today.
- The share of GDP devoted to government is likely to remain flat or fall slightly. This is good news because it creates more room for private sector growth.
- Housing is still on the rise, while income and jobs are strengthening.
- Most importantly, new entrepreneurial technology is boosting productivity, growth, and profits.
The bottom-line is that negative sentiment of the past week or so in the markets might turn into a full-fledged correction, but this would not likely be the end of the bull market, or the economic recovery. Nothing fundamental has changed in our outlook for the US economy.
We have been through these “risk-off” periods many times in the past few years. Dubai, Greece, Italy, Spain, Cypress, the government shutdown, BP’s spill, and the first fears of tapering last summer – just to name a few! All of them turned out to be inconsequential for US stocks and it’s highly likely the same is true this time around.
Financial news shows and publishers love this stuff because fear motivates people to watch TV (and the commercials) and buy financial publications as they look for an explanation of what is happening.
When you get a chance, watch the financial news not as a consumer but rather from the point of view of a marketer. Notice how everything, from the countdown clocks, to the “crawl” at the bottom to the doomsday segment titles (“Dow Crushed 300 Points!”) is designed to draw your eyes to the screen and watch their commercials. It’s always about the bottom line- ad revenue. Everything else is secondary; which is why we almost always mute our office TVs.
We hold ourselves to a somewhat higher standard and as custodians of your wealth, we try to cut through all the noise to develop individualized financial and portfolio plans for each client. We continue to advocate trailing stops and asset allocation as strategies to prevent a permanent impairment to wealth but we do not think current conditions require fundamental changes to our investment process.
Takeaways
- As much as we believe the emerging markets will be key growth engines of the future, it still looks premature to place a large part of a portfolio in those areas. The currency issues are serious and they only elevate the risks in those markets. Having some exposure to those markets is fine, after all, this might be a fast-moving storm, but we would not suggest anyone tie the fate of their portfolios to these markets. Yes, they are inexpensive compared to their historical valuations; but they are structurally challenged at the moment. As a result, they appear to be cheap for a reason and not mispriced.
- There’s a pretty good chance this recent lull in the markets will continue. January 2014 may be down a few percentage points, but we don’t see any economic or market-driven cause for alarm. A rest has been due for a long time. It’s natural and healthy. Growth continues around the world and the recovery story throughout Europe also continues to come into focus.
- Looking at the full year ahead, our expectation is that the global economy and developed financial markets should continue to advance in 2014, but at a slower pace than the optimists predict.
Jeff and Ken, Orlando Financial Advisors
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