At the time of this writing, the Standard & Poor’s 500 index is down 5.2 percent from its all-time high, which it reached in September. While investors who have gotten used to seeing markets climb may be concerned by this, long-term investors shouldn’t seriously consider rushing to make changes to their portfolios.
The financial media, who can be counted on to magnify any fluctuation in the stock market, has done what we can expect them to do. A quick perusal of financial websites yields such phrases as “wild swings” and “extreme turbulence,” and tells us that we are seeing “shares crumble.” These descriptions are a far cry from what we saw less than a month ago, when the S&P 500 hit a new all-time high. After seeing stocks climb so rapidly over the last few years, how can investors reasonably view this decline as a serious cause for concern?
Some investors are acting like this is one of the worst declines they’ve ever seen because, well, it’s one of the worst declines they’ve ever seen. As measured by the S&P 500, the stock market has climbed each calendar year since 2009. The last time the market dropped over 10 percent was the summer of 2011, so we have seen over three years of almost uninterrupted appreciation. Over the summer, measures of daily volatility reached their lowest levels since 2009. Certain young investors have reason to believe that everything they’ve observed the last few years was normal, and that recent declines can only be the beginning of something much worse.
There are plenty of stocks outside of the S&P 500 index, and other indices focusing on international and small-cap stocks have fallen farther from their recent highs. Because of this, an investor with a diversified portfolio should have seen the value of their equities fall more than 5.2 percent recently. But that same equity portfolio should have also appreciated substantially over the last few years, more than making up for the recent drop.
Some analysts are making the case that the stock market has become too expensive and has nowhere to go but down, because the prices of shares have simply been bid too high. Of course, a stock that looks overpriced to one investor may look like a bargain to another. Valuation is subjective, more of an art than a science. For someone who bases an argument that stocks are overvalued on one measure, such as the S&P 500 rolling 10 year price-to-earnings ratio, this can lead to counterarguments based on many other measures that indicate stocks aren’t particularly expensive, such as the current S&P 500 price-to-earnings ratio or earnings yield. Most, if not all, investors should be able to agree that stock prices today are not approaching the bubble territory we saw in the 2000-02 tech market collapse. And while the losses incurred during that period were steep, investors who diversified and remained disciplined saw their portfolios fully recover, and then some.
Of course, the stock market is forward-looking, and there is no shortage of issues to cause concern about the future. Many investors worry about the likelihood of the Federal Reserve stimulus ending next year. Investors hate uncertainty, and the Fed will enter uncharted territory as it stops buying bonds and begins to finally raise interest rates. Instability in various parts of the world, including the Middle East, Hong Kong and Eastern Europe, also worries investors. Falling global economic growth could lead to serious problems down the road, including more instability and uncertainty. Because of this, many short-term investors have made snap decisions to sell out of their equities and wait for stocks to fall before buying back in. This is a strategy that no investor has shown the ability to execute consistently over the years, but that certainly doesn’t stop people from trying.
Ultimately, disciplined investors facing up to today’s market environment have to decide whether they believe the global economy and global stock markets will be better or worse off in the years and decades to come. At Palisades Hudson, we continue to monitor our clients’ portfolios and do our best to understand the trends shaping the world around us. Considering that we stayed true to our investment principles through the bear markets of 2000-02 and 2008-09, it would take a lot more than these recent events to make us seriously concerned about the future. If anything, recent declines have led to opportunities for us to rebalance client portfolios and purchase equities at lower prices.
There will be recessions and bear markets in the future, but we cannot say with certainty when they will arrive. But we can continue to manage risk, keep expenses down and stay disciplined. That’s always been our approach, and recent volatility hasn’t done anything to change that.