There are plenty of opinions about the direction of the US stock market or how likely we are to have a correction. We have a number of clients who have been waiting for a correction to occur so that they can put more cash to work. There were numerous predictions of doom in 2016. It’s true that a correction can happen at any time.
Normally, corrections of 10-20% occur about every 18 months. A bear market is defined as a drop of 20% or more that lasts more than 2 months. Historically, bear markets tend to happen about once every four years. It’s unusual that we have gone this long without a serious correction or bear market. When panicked speculators sell, experienced investors buy. Patient investors have time on their side and can weather the inevitable temporary declines.
Our fiduciary-based investment process approach is to have an appropriate investment strategy for every individual client and then stick to it. An investor with a moderate return objective and risk tolerance should have a moderate allocation regardless of market conditions. The research is clear that this discipline produces better results than trying to time the market. Our approach includes having enough cash to pay a year’s worth of expenses so that any sales do not have to be made at inopportune times. Part of our review process includes rebalancing portfolios to their target allocation. Portfolios include active and passive managed positions that have passed our due diligence screens and feature investments with low internal expenses. Index funds track the general market and can be overly influenced by a few stocks because of their size or particular characteristics. Actively managed funds that avoid over priced stocks can add value in volatile markets.
“In our opinion, the valuation of U.S. equities is a moderate concern at this point. Granted, economic, earnings and political disappointments are not as easily ignored now as they might be at lower valuation levels. Nonetheless, until interest rates start to rise at a faster-than-anticipated pace, or the U.S. economy shows early signs of entering a recession, we will continue to view price corrections as buying opportunities. In the meantime, the world economy appears to be on the mend. Geographically diversified equity portfolios that have had a tough time keeping up with the S&P 500 Index may begin to outperform.
In fixed-income markets, we anticipate the normalization of interest rates to higher levels to proceed at a sedate pace. We don’t believe that inflation is the global economy’s biggest problem. We believe it’s a lack of growth. That seems to be changing, but we do not expect aggressive tightening by central banks. The Fed may be leading the way, but even it is likely to tread carefully until inflation becomes a bigger problem. This should limit the dangers of a debacle in the bond markets. It also provides a favorable backdrop for an equity market that continues to defy the naysayers.” SEI Private Trust Company 4/7/17 Quarterly Market Commentary
We recently met with representatives of money management firms that we respect. They commented about the worldwide recovery in economic activity that they feel bodes well for improving stock prices of non-US companies. Valuations are lower for non-US stocks as our markets outperformed international equities for the last 7 years. Another point worthy of consideration is that our Federal Reserve is tightening monetary policy while foreign central banks remain extremely accommodative. For balance, political and individual country risks need to be monitored.
“The worldwide recovery in industrial activity continued to bolster the most synchronized global expansion in the past several years. While growing political uncertainty surrounding the prospects for U.S. economic policy changes caused a reversal in post-election, policy-related trades, stock market volatility remained at extremely low levels. Supported by a weaker dollar, non-U.S. equities led the Q1 global stock market rally; for the first time in years, emerging-market equities outperformed U.S. large-caps on a one-year basis.
Amid signs of moderate-but-not-overheating economic expansion, flattish bond yields helped support a solid backdrop for most asset categories. As inflation indicators firm, monetary policymakers turn less accommodative, and the U.S. business cycle becomes more mature, smaller allocation tilts are likely warranted. As the year progresses, the uncertain outlook for U.S. economic legislation and upcoming elections in core European countries—including presidential elections in France during Q2—could boost market volatility.” Fidelity’s 4/14/17 Quarterly Market Update
The US economy was starting to improve in late stages of the election cycle. The Federal Reserve started raising interest rates, which is a sign of a healthier economy. Positive job reports and increases in measures of inflation are further evidence of economic growth. Corporate earnings are improving and confidence is at levels not seen for many years. The first quarter’s excitement about the new administration’s fiscal policies has been tempered by the reality of how long it will take for companies and individuals to feel the results.
Market volatility has been very low. Our outlook is that the rest of 2017 will be more volatile and that 2017 equity market values will end higher as US and world economic fundamentals improve. Fixed income positions are expected to fulfill their role as a cushion to portfolio values. So far, rate increases have not hurt stock prices.
Acknowledging the possibility of a correction is a good exercise and a time to remember that equity investments are long term investments and temporary pullbacks should be seen as opportunities to buy more shares at lower prices. The returns available from cash and bonds alone will not outpace inflation and accomplish the growth necessary to accomplish your financial goals.
Please call with questions about your portfolio or if your circumstances changes. It’s important to keep us posted as to your potential cash needs.
Michael Devine, MSFS, AIF ®/ Becca Cummings, CPA, AIF® / Eric Bleiler, CPA/PFS CFP®