You may have noticed that, so far in 2016, the stock market is tumbling!
As a result, you might have concern about the future of your investments.
In fact, if you read the financial news, I’m sure you’ve read some fairly scary headlines, and you might even be slightly alarmed.
I know watching your investments plummet can be scary, but if you were my client, you’d be completely confident that your investment and financial plan were on the right track.
Here’s a summary of recent market events, and my note to clients of my firm about the condition of their investment portfolios:
First, What Happened to the Stock Market?
In the first trading week of 2016, the S&P 500 was down 4.88% and the MSCI EAFE (Europe’s S&P) was down 5.45%. Markets have continued to fall this week.
In a Nutshell, Why Did Investors Get Nervous?
Recent price declines are largely caused by uncertainty in China that includes the Chinese economy, as well as its stock and credit markets, combined with potential future rate hikes by the US Federal Reserve.
How About Some More Details About What Happened?
Your wish is my command…
China devalued its currency on Tuesday, January 5th
- Stocks tumbled across the region
- Global concern that the Chinese economy might be significantly weaker than expected, raising the specter of deflation
- Major implications for US and other countries that trade with China, with US companies disadvantaged and trade with China slowing
- Pressure on other central banks to weaken their own currencies to support their exporters
Investors are uncertain about future Fed rate hikes
- Considering what’s happening in China, investors may have been hoping that the Fed wouldn’t raise rates again until June, but the strong growth and jobs report released Friday is being taken as a sign that the Fed will continue with the expected plan to raise rates another 0.75% over the first half of the year (Note from Hilary: interesting how “good news” isn’t always perceived as such, isn’t it?)
Falling oil prices are driving a lot of what's going on
- Lower oil prices mean declined performance not just for oil companies, but also for anyone who does business with oil companies (pipeline companies, energy service providers, banks, etc. On the other hand, while that's not good for your investments, it's actually great while you're standing at the gas pump.
So, What Does This Mean to Me?
The first thing you should know is that, despite news outlets such as Bloomberg and the Wall Street Journal reporting this to be the worst start to the year for the S&P 500 and the Dow Jones Industrial average, these negative returns are actually quite ordinary.
The table below shows the number of weeks in the last 15 years (2000 – 2015) that the S&P 500 and MSCI EAFE indexes have dropped by the following levels:
Market declines can be painful and scary, but they are normal.
NOTE: THE REMAINDER OF THIS ARTICLE COMES DIRECTLY FROM AN EMAIL I RECENTLY SENT TO CLIENTS. IT APPLIES ONLY TO THEIR INVESTMENT PORTFOLIOS. IF YOU DIDN'T RECEIVE TIMELY COMMUNICATION FROM YOUR ADVISOR, OR YOU APPRECIATE THE EVIDENCE-BASED APPROACH I TAKE TO THE INVESTMENTS MARKETS, SCROLL DOWN FOR HOW TO CONTACT ME TO ENSURE YOUR INVESTMENTS ARE HEADED IN THE RIGHT DIRECTION.
- Neither I nor the Nobel Laureates and investing experts who work on my Investment Committee can find anything to suggest that anything has changed in the way people view and invest in the markets.
- Capitalism and trade are alive and well, and markets are continuing to function properly and incorporate information efficiently.
Another way to say this is to say that we have every right to expect positive returns to on average going forward.
Let me give you an example by testing your knowledge of probability:
If I’m rolling two standard six-sided dice and you’re picking the outcome (the sum of the two dice, any number between 2 and 12), which number should you pick?
The answer is always 7.
7 is the most likely outcome because there are six different ways to roll a 7 and, over a very large number of rolls, it will come up more frequently than any other number.
But, what if it’s my tenth roll and I haven’t yet rolled a 7? What number do you pick now?
And, what if it’s my 1,000th roll and I haven’t rolled a 7?
7 is still the most likely outcome in the next roll, past history aside.
In the very same way, there are “most likely outcomes” in the stock market, and your portfolio has been constructed to bet on those most likely outcomes.
I have relied heavily on the work of Nobel Laureates and academics to focus on investing in asset classes that create better portfolios. Given 200 years of stock market history, our expectation is that they will perform the best for you over time.
In the chart below, you can see the annual returns for the most well-known investment asset classes.
The returns are ranked from highest to lowest each year. We use this history of returns to build a balanced portfolio for you that includes all the appropriate asset classes and prudently tilts toward the ones that historically have performed the best.
Therefore, we generally expect positive returns, just as we generally expect it to be sunny in California in the summer and rainy in Seattle in the winter.
As you can see, even though we have a right to expect positive market returns each year, returns can, in fact, be negative.
Not only that, but just as in the case of rolling two dice where short-term outcomes are random (otherwise no one would play Craps!), we also have no idea how any individual asset class will perform in 2016.
In fact, just like we can have consecutive rolls without a 7, it’s totally normal to have negative overall returns in consecutive years, just as in 2000, 2001 and 2002 (though three years is pretty unusual).
The returns vary from year to year and no asset class is consistently at the top or bottom of the chart.
And, because we have no way to accurately predict the winners and the losers each year, it’s very important to stay the course, especially in challenging times.
Even though outcomes are likely and expected, they don’t always happen. Regardless, we don’t abandon our strategy.
Remember that according to Warren Buffett…
As an investor, your own emotions can be your worst enemy. The key to overcoming emotions is being able to retain your belief in the real fundamentals of business, and don’t get too concerned about the stock market.
Remember that according to Hilary Hendershott…
All long-term changes in the stock market are a function of the value produced by companies and enjoyed by people. Short-term changes are a function of irrational investor emotion and always get ironed out in the long-run. Your best bet? Even when the stock market is tumbling, be a long-run investor.