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WHEN MARKETS GO crazy, financial writers feel compelled to dust off the keyboard and cook up profound insights. But I am writing this at 5 a.m., while still ingesting my first cup of coffee, so I’m setting the bar a little lower. Here are 12 modest observations following yesterday’s 4.1% plunge by the S&P 500:
1. I don’t know. You don’t know. Nobody knows. The market turmoil of the past six trading days feels like a sea change after 2017’s remarkable calm. Our instinct is to try to divine what it means for the months ahead. But the reality is, nobody can forecast the stock market’s short-term direction.
2. Keep it in perspective. What we’ve suffered so far is a minor 7.8% dip after an astonishing run that saw the share prices of the S&P 500 companies climb 292% from March 9, 2009, through their collective all-time high, set just six trading days ago, on Jan. 26. Losing almost 2,300 points on the Dow Jones Industrial Average over six trading days may feel like a big deal, but it isn’t a big percentage.
3. There isn’t one strategy for everybody. We’re all at different stages of our lives, have different goals and different personal tolerances for risk, and we have different portfolios—some of us underweighted in stocks and wanting to own more, others over-weighted and wondering whether to sell.
4. Instead of fretting about where stocks are headed, focus on risk—with a particular focus on two questions. First, do you have money in stocks that you’ll need to spend in the next five years? For instance, do you have dollars in stocks earmarked for your teenager’s college education or for the next five years of your own retirement? Seriously consider moving those dollars to a money-market fund or a high-quality short-term bond fund. With stocks within spitting distance of their all-time high, you’re likely still booking hefty profits. In fact, you’ll be selling at the handsome prices that were on offer as recently as December.
Second, has the market drop made you realize you’re less brave than you imagined? If this is a true bear market—and I’m not predicting it is—prices could potentially fall far further. As I’m fond of saying, it’s much better to sell in a panic when stocks are close to their all-time high, rather than waiting until they’re 30% lower. It isn’t “too late” to sell. Far from it.
5. If you’ve been sitting on cash, waiting for a great buying opportunity, you’ll have to wait longer. Better still, stop waiting and start buying—slowly. Figure out how much you want in stocks, divide it into 24 or 36 equal sums, and then spoon that money into stocks over the next two or three years. If share prices drop 15% from their Jan. 26 high, double the size of your monthly purchases. If the market falls 25%, triple your monthly investment.
6. If you’re more than 15 years from retirement, you have two tasks. First, pray mightily for a major market decline, so you can buy stocks at cheaper prices. Second, step up your savings rate to compensate for what will likely be modest long-run stock market returns.
As I noted recently, over the past three decades, share prices have climbed 3½ percentage points a year faster than economic growth, thanks to widening corporate profit margins and rising price-earnings ratios. This could, I suppose, continue—but it’s unreasonable to expect it, so protect yourself against modest returns by saving at least 12% of pretax income every year toward retirement and preferably 15% or even more.
7. Even if you’re happy with the portfolio you hold, you’ll want to take advantage of the market decline—assuming it continues—by rebalancing back to your portfolio’s target percentage for stocks. Many folks rebalance once a year. But you might decide that you’ll rebalance earlier if, say, the market declines 20%. Write down your trigger for rebalancing and stick it on the refrigerator.
8. In fact, write everything down and stick it on the refrigerator. What’s your plan? What target mix of U.S. stocks, U.S. bonds and foreign shares are you aiming to hold? Which investments will you buy? How much will you save per month and at what market level will you rebalance? As markets gyrate, it’s all too easy to “revise” our decisions if they exist only in our heads. It’s tougher when we’re confronted with our own words on a piece of paper.
9. Two hoary Wall Street clichés have been trotted out in recent weeks: that bull markets don’t die of old age and that stocks don’t go down simply because they’re overvalued. Yet the two popular explanations for why stocks have declined—because of inflation fears and rising interest rates—seem pretty thin.
After all, as I type this, the 10-year Treasury note is at 2.72%, not much higher than the 2.41% at year-end 2017. This seems like a classic example of investors cooking up a simple story to explain complicated markets driven by millions of individuals making disparate decisions.
10. Pundits talk reassuringly about the strength of the U.S. economy, including last year’s fairly decent economic growth and today’s low unemployment rate, with the recent tax cuts layered on top of that. All that is true. Problem is, investors look forward, not back. The economic news seems likely to stay good for at least another year—but maybe investors sense it won’t be good enough to justify current share prices.
11. The S&P 500 is trading at 32.1 times its 10-year average inflation-adjusted earnings—otherwise known as its cyclically adjusted price-earnings ratio or Shiller P/E—well above the 50-year average of 19.9. I’m not predicting that share prices will fall back to that average. But don’t let anybody tell you that U.S. stocks are cheap.
12. Foreign stocks, including emerging markets, are better value, and investors seem to be recognizing that: After a long stretch of wretched performance, developed foreign markets finally outpaced U.S. stocks last year, while emerging markets have now had two years of outperformance.
Back in the 1980s, U.S. investors might have kept 10% or 20% of their stock portfolio abroad. Today, I think 40% and perhaps even 50% overseas makes sense, both for diversification and because of valuations.
Over the past year or so, a tumbling dollar has made foreign shares more valuable for U.S. holders. But imagine the roles were reversed—and you’re a foreign holder of U.S. stocks. Not only have U.S. share prices lately looked shaky, but also you’re losing money on the currency. An open question: If the market turbulence continues, will foreign investors rethink their allocation to U.S. stocks and bonds, and could that add to the selling pressure?
Follow Jonathan on Twitter @ClementsMoney and on Facebook.
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