I thought it would be important to reach out to give a quick update on some of the facts regarding what’s been going on in the stock and bond markets recently as we approach the end of 2018 and look into 2019. I’ll try to make this short but concise, and stick with what we know and what we don’t!
In an earlier letter to all clients at the end of September, I mentioned we were overdue for a bear market, which is defined by Investopedia as decline of 20% or more.1 As I write this the day after Christmas, the S&P 500 index has now officially declined 20% from it’s high on September 21. The Dow Jones 30 Industrials index is not quite there, but very close. The NASDAQ 100 index is down more than 20%. Google is down about 23%, Apple down about 37% and Netflix down over 40%. So it’s safe to say we’ve achieved bear market status.
Bear markets typically happen about every 3.5 years. Doing a little research, I found the average bear market decline was 35.4%.2 This could indicate the current bear market has a while yet to run. The average bear market lasts about 10 months – we’re just over 3 months into this one. It’s easy to say that investors should get out at the top of the market and back in at the bottom, right? In reality, this is quite hard to do since we only know the high and the low in hindsight. So how do we manage risk in client portfolios?
There are multiple ways to handle risk. Many investors and advisors build diversified portfolios that hold assets other than stocks, such as bonds. Earlier in the year as interest rates worked higher (often bonds drop in value as interest rates rise) our bond portfolios were a drag on performance but we always anticipated that when we finally saw the larger correction the bonds would help us manage through it. This has proved accurate as the bond holdings now are helping protect capital. During the last couple of years, we also recommended and invested in FDIC-insured market-linked Certificates of Deposit for clients wishing to protect a portion of their portfolios. While these are priced somewhat in relationship to the value of their underlying holdings, which have been generally lower, they do have FDIC insurance protection at maturity so we feel comfortable that these will protect capital. As a result of these actions, for those people who have completed risk tolerance surveys we believe their portfolios should be pretty well aligned with their stated risk tolerance.
Other options we have used include traditional CDs, fixed index annuities, high quality (or insured) bonds that you can hold to maturity, or buying put options (a little more complicated strategy). But in general, our plan through corrections (and I’ve lived through 5 of them in my career) is to help you build portfolios that can potentially help you keep risk within your comfort level. If your risk comfort level is high, it’s true that stocks have outperformed many alternatives and based on an NYU study has vastly outperformed government-guaranteed United States treasury bills and bonds.3
What is ahead? Most likely uncertainty. A weak or slowing economy may bring on a bear market — the signs of a weak or slowing economy are typically low employment, low disposable income, weak productivity and a drop in business profits. That doesn’t seem to be the case right now, however. In addition, any intervention by the government in the economy may also trigger a bear market. We may be seeing that with the China tariff situation. A drop in investor confidence may also signal the onset of a bear market.
But at these levels, many stocks are fairly priced based on their historical price/earnings ratios. It’s a little like a sale at a department store. When you see a sale where an item is 20% off, you know that is a better price than it used to be. But what you don’t know is if that item might be marked down further – which would represent a better deal! While there are in general no guarantees in investing, I’m as confident there will be a rally next year as I was earlier this year that there was a correction coming around the corner. So I do not believe this is a good time to be a seller. It’s probably a better time to be a buyer but the “mark downs” might not be done yet, either. Patience is the best virtue to have here. If you believe your risk tolerance is changing as you watch the market move, we should use the next rally as an opportunity to shift your portfolio to a more conservative mix.
Feel free to give me a call if you wish to discuss this further.
Please note – investing involves risk, and past performance is no guarantee of future results. The publisher is not engaged in rendering legal advice or accounting services. If assistance is needed, the reader is advised to engage the services of a competent professional. This information should not be construed as investment, tax or legal advice and may not be relied on for avoiding any Federal tax penalty. This is neither a solicitation nor recommendation to purchase or sell any investment or insurance product or service, and should not be relied upon as such. All indices are unmanaged and are not illustrative of any particular investment.
Securities and Registered Investment Advisory Services offered through Silver Oak Securities, Inc., Member FINRA/SIPC. Silver Oak Securities, Inc. and Cornerstone Financial Group are separate entities.
1 – https://www.investopedia.com/terms/b/bearmarket.asp
2 – https://www.gold-eagle.com/article/history-us-bear-bull-markets-1929
3 – http://pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/histretSP.html