Sense and Sensibility

Stocks around the world have slumped in the last days. So a quick round of FAQs:

Was this expected?

·       Oh Yes! Stocks have been rising pretty much in a straight line since November 2016, and that's not exactly healthy.  The stock market is long overdue for a 5% pullback or even a 10% correction.

Was this unusual?

·       People have very short memories so let’s look at history. While the point decline on the Dow was large, it paled in comparison with the scary days of the financial crisis. Friday's decline was 2.5%. The Dow plummeted nearly 8% on a single day in October 2008. When the Dow lost 500 points in 1987, it was a 22 percent decline. But this market's nosedive only amounted to a 8% decline — still "awful," but not a crash

·       On average, there’s been a market correction every year since 1900. A correction is defined as a drop of at least 10% but not more than 20%. A bear market is a drop of more than 20%

·       The slide does little to dent the overall gains the market has achieved since President Trump's victory. The Dow and the Nasdaq have climbed more than 40% apiece since the 2016 election.

Why did it happen?

·       It is suspected that the sell-off came after the US labor department released a better than expected monthly jobs report. The economy added 200,000 jobs in January, and wages grew at the fastest pace in eight years. But if wages grow too fast, they could eat into Corporate America's record profit margins.

·       Wage growth could be a sign that inflation may heat up. That would force the Fed to raise interest rates faster than investors may be comfortable with. This can also damage corporate earnings

·       The recent tax largesse has forced the Treasury to borrow more money, which will put more bonds into play. A supply glut could devalue bonds. Prices and yields move in opposite directions, and bond buyers will want a higher yield (and lower price) to make it worth their investment. And in any case bond investors would want higher returns to compensate them for rising inflation

·       Higher returns on bonds may make stocks look less attractive by comparison.  Stocks are riskier than bonds and if bonds give anywhere close to the return as stocks, people may flee stocks and buy more bonds, slowing down the rise of equities. But it may take some time to get to that point

·       Political turmoil is adding to the uncertainty. The clash between the Trump administration and the FBI is a big factor

Where is the market headed?

·       This of course is the trillion-dollar question. But don't expect a bear market unless there's an actual downturn in the economy.  The good news is that the economy is doing quite well and so are companies

·       80% of stock-market corrections don’t turn into bear markets. Historically, the average correction has sent the market down 13.5% and lasted 54 days — less than two months.

·       But if jobs growth improves and wage inflation increases in the short term, then equities may remain compressed due to the fear of rapid interest rate hikes

In all cases, expect volatility to pick up in 2018

What should investors do?

·       A cooling-off period is actually a good thing. It would make stocks cheaper and more attractive to investors, especially if the underlying companies are healthy, cranking out strong sales and profits.

·       If you panic and move into cash during a correction, you may well be doing so right before the market rebounds. As Buffett once said, “The stock market is a device for transferring money from the impatient to the patient”

·       The S&P 500 experienced an average intra-year decline of 14.2% from 1980 through the end of 2015. In other words, these market drops were remarkably regular occurrences over 36 years. The market ended up achieving a positive return in 27 of those 36 years. That’s 75% of the time! And of course if you invest in stocks you should expect volatility; no risk no return!

America’s economic magic remains alive and well. For 240 years, it’s been a terrible mistake to bet against America. And now is no time to start.