The New York Stock Exchange, photo by Billie Grace Ward
The S&P 500 has fallen 6.5 percent from its all-time high in September. After years of sunny skies, the October downturn created the same stomach-dropping sensation as dark clouds appearing in the middle of an afternoon picnic.
Investors are now scrambling to answer a couple of key questions: What caused the drop? And will the downturn continue?
The first question is reasonable. When the stock market declines, investors can usually identify one or two obvious culprits. This time, however, it’s not so simple. Initially, some observers blamed a rise in interest rates. Some investors fear that rates are rising too fast, especially since the Federal Reserve is unlikely to change course due to a stock market correction alone, making debt more expensive for businesses and consumers alike. But interest rates have not changed much at all during this period of volatility, with the yield on 10-year U.S. Treasury bonds essentially unchanged since the stock market peaked in September.
There are many other factors that could have caused the reversal, together or separately. Some investors are worried about the escalating trade dispute between the U.S. and China, especially after recent reports that any failure in next month’s trade talks may result in yet another round of tariffs on Chinese imports. Others worry that U.S. economic growth is nearing or has reached its peak, as have corporate earnings. Stock prices, by their nature, build in investor assumptions. Some of these assumptions may have been too optimistic, especially for high-flying technology stocks such as Amazon and Netflix. When assumptions about a company’s long-term growth prospects change, even slightly, it can significantly affect the stock price.
There are other possible sources of investor worry, too. Slowing economic growth in China, the world’s second-largest economy, is sparking concerns. Italy faces a budget crisis; Europe is nearing the end of quantitative easing; and the Brexit process remains a major source of uncertainty for global investors. American investors are also unsure what to expect ahead of next week’s midterm elections, further increasing volatility.
As for the second question – “will the downturn continue” – no one can honestly answer it, because no one knows. It is impossible to say for sure how long or how severely stocks will decline. This downturn could continue, or stock prices could quickly rebound. Nothing in investing is guaranteed, now or ever. But there are a few key truths investors should keep in mind.
After years of seemingly uninterrupted appreciation, some volatility may simply represent a return to normal conditions. We have not seen a bear market (a stock market decline of 20 percent or more) in almost 10 years, and the last correction (a decline of 10 percent or more) was in 2016. Since March 2009, the S&P 500 has quadrupled without accounting for dividends. Stocks are supposed to be somewhat volatile, not appreciate month after month, year after year, with no dips along the way. Cycles are a normal part of investing.
In addition, by most measures our economy is still very strong overall. The Commerce Department reported that the economy grew 3.5 percent in the third quarter, a strong showing in both historical and global context. Unemployment hit the lowest level since 1969 in September, and U.S. consumer confidence recently reached an 18-year high. While it is fair to observe that no economy can expand forever, the basic fundamentals underpinning the stock market are sound and are unlikely to evaporate overnight.
Bearing this context in mind, investors should view current market conditions as an opportunity, not a disaster. As always, it pays to understand your investments and realistically assess your own risk tolerance. You should stick to your long-term financial plan, and resist the urge to join the herd or try to time the market. But while you don’t want to act hastily, there are some reasonable actions you can take to make the most of a stock market slump.
You may want to rebalance your portfolio in order to keep your asset allocation on track. In a downturn, stocks are essentially on sale, which can make it a great time to add to underweight positions. Especially if you have a long time horizon, a downturn can ultimately help your portfolio overall, as long as you do not panic and lock in your losses by exiting the market entirely. A downturn may also be a smart time to consider tax-loss selling. If you hold securities that have lost value in a taxable account, selling in order to realize capital losses and investing the proceeds in similar securities can reduce your tax bill.
No one, including me, knows exactly what’s next for the stock market. But for investors with a well-designed, long-term investment plan in place, the October slump is no reason to panic – and, in fact, may represent some opportunities that investors have not seen for quite some time.