While Jim is away on vacation, other members of the TBA Investment Committee will write the market comment. Today’s comment is from Ray Reed.
As analysts and investors, we seek to understand what drives markets and individual stocks on a long-term basis in an effort to produce competitive investment returns for our clients and help them achieve their financial objectives. Intellectually, we know that making short term predictions about STOCK market performance is at best challenging, although those of us who watch stock market news on television (or other media platforms), or read market analyses and commentaries, are bombarded with prognostications about the immediate direction of the market in the next hour, day, week or month. This seems to be particularly the case when market averages peak, roll over and price volatility increases.
After a sharp recovery in the first four months of 2019 from the nasty, almost bear market correction in the fourth quarter of 2018, the averages rolled over in May with the S&P 500 on track to give back around 6% of its gain since the recent peak on May 1. There are many reasons to explain this recent selloff including higher valuations following the sharp rally combined with continuing growth and earnings concerns, Federal Reserve policy on interest rates, a particularly partisan political environment, geopolitical risk and, perhaps most importantly, disappointment over the lack of a trade deal resulting in the escalation of tension between the U.S. and China combined with a new threat on Friday by the President to impose tariffs on Mexico.
That said, market volatility is normal and while downturns are unsettling, history suggests that the market always recovers from declines (at times more quickly than others) and consistently produces long term positive returns that beat inflation. According to an analysis by Fidelity, the market has experienced an average drop of 14% per year from the high to the low over the last 35 years, yet produced positive annual returns in 80% of the years during this period. That said, one’s ability to withstand volatility, no matter how long or short lived, depends on having adequate diversification among equity investments as well as understanding risk tolerance (are you lying awake at night worrying about the market?) and establishing and regularly rebalancing to an asset allocation that is appropriate to and comfortable for one’s time horizon (more time/more risk/higher returns) and income versus growth objectives. Importantly, investment programs, such as 401(k)s and 529s, which essentially allow investors to make regularly scheduled investments over time, and long term returns benefit from dollar cost averaging during up and down markets.
The media drum beat about the short-term direction of the market begs the question about whether market timing is a worthwhile strategy. It is often the case that market timing results in poor investment decisions–selling when stocks are cheap and buying when they are expensive. Numerous studies have shown that missing the best five or ten best days in the stock market over the long term can result in sharply lower returns than staying fully invested throughout the period. The chart below illustrates this impact using the S&P 500 from an inception date of January 1, 1980.
Whether the current bout of market volatility portends another correction or a bear market is anyone’s guess, though a timely resolution to the US/China trade issues would likely be a favorable catalyst for the market in 2019, especially for companies exposed to China trade in some important aspect of their business. Unlike 2017, when world economies were improving synchronously and earnings revisions were generally positive, the economic backdrop and outlook are less clear or robust today and is being compounded by uncertainty created by the trade dispute with China and other trading partners. As is often the case, however, market declines don’t treat all stocks equally and can create opportunities to buy great companies at attractive valuations as well as upgrade portfolio quality by selling stocks of companies with deteriorating fundamentals in favor of well positioned or better businesses at reasonable prices.
Raymond F. Reed, CFA 610-260-2228