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Mild Indigestion

Jonathan Clements  |  August 22, 2015

WHAT SHOULD investors make of the stock market’s decline? Start with three ideas. First, the S&P 500 has fallen a mere 7.5% from its all-time high, set in May, so the “global market rout” looks more like a mild case of market indigestion.

Second, while the S&P 500 declined 5.8% last week, we can be confident that the underlying, fundamental value of these 500 corporations didn’t deteriorate 5.8%. As usual, investors are trying to figure out the future, and it’s a crude guessing game driven by twitchy investors with short time horizons.

Third, while nobody knows what the stock market’s fundamental value is, it would be hard to argue that U.S. stocks are cheap. U.S. shares might be reasonably valued relative to U.S. bonds, but all that’s telling us is that both will likely generate modest long-run returns from current levels. By contrast, foreign stocks, and especially emerging markets, look like a decent buy if you’re a long-term investor.

So what should investors do? At this juncture, I wouldn’t do much. If you’re regularly contributing to a 401(k) plan or spooning money into an IRA, I would keep it up. If you have less than 30% to 40% of your stock portfolio allocated to foreign stocks, consider directing more of your regular purchases to international markets, and particularly emerging markets.

We aren’t, however, anywhere close to the moment when you should back up the truck and start buying U.S. stocks like crazy. To do that, I would want to see U.S. shares down 25% from their high. Sure, there’s a chance that markets will rally from here. But even if there’s an impressive short-term bounce, today’s buyers of U.S. stocks won’t be looking at great long-run returns, because they’re purchasing at rich valuations.

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