Perspective About Recent Market Turbulence

stock market stress_perspective article smThere are no two ways about it – these last two weeks have been very trying.  Sectors were crushed. Oil slipped below $38 a barrel then shot back up over 27%. Individual stocks broke 52-week lows… then some yo-yoed to new highs. This experience will expose the difference between “traders” and “investors”… and what lessons we can take away from the markets rollercoaster ride.

If you spent the past ten days glued to the markets as we did, you may be feeling a bit… numb.  Perhaps you’re questioning if all the stress is even worth it. (Admittedly, an Internet-free vacation somewhere on a lake in the woods does sound mighty tempting right now…) You may even be asking yourself, “Why am I invested in the market, anyway?”

To many of us, the health of our portfolios offers peace of mind… it enables us to explore our true passions in our lives. And, for some, it’s the safest, easiest  – and most liquid – way to begin establishing lasting wealth by owning a diversified portfolio of investments. Not just stocks, but also a basket of bonds, Treasuries and precious metals…not to mention, fixed indexed annuities and cash value life insurance that some of us (including Sharyn and I) own as part of our retirement plan.

bear bull market imageryWill there be more volatile times?  Absolutely.  Markets move in cycles. Bears follow bulls, bulls follow bears, etc. But history has shown that disciplined investors – with a proper allocation of holdings – greatly outperform the herd. In the end, it’s only your own state of mind that can hamper or bolster your profitability.

How Emotions Govern Our Actions

It’s often been said that the average investor’s downfall is fear and greed.  He tends to be too greedy to sell at market tops and too fearful to buy at market bottoms.  Yet fear and greed aren’t an investor’s worst emotions; we can actually use them to our benefit.

greed is goodGreed – more palatably known as “rational self-interest” – is what keeps us on the hunt for worthwhile opportunities. If we didn’t feel a desire to improve our lifestyle and circumstances, we wouldn’t undertake ventures. The free enterprise system – the greatest engine of prosperity the world has ever known – requires risk takers. We need entrepreneurs to start companies and investors to capitalize them. In short, Gordon Gekko got it right.  Greed – the desire to get rich – is good.

Fear is another essential ingredient. It keeps us from getting carried away.  Fear reminds us that the pursuit of wealth has a downside: loss.  And, as we have seen, it can be painful.

Fear and greed balance each other. Greed keeps us looking up. Fear reminds us to “look out below!”

However, after working with hundreds of individual investors, I’ve learned that what sinks too many investment plans is not fear and greed, but hope and regret…

Hope, in particular, has no place in any serious investor’s tool kit. Finding yourself saying “I hope the market keeps going up” or “I hope this stock turns around and starts going the right way” is like hoping no one checks your alibi or audits your tax return. It’s a clear indication that you’re not thinking clearly.

We invest in stocks not because we hope the current trend will continue for another month or another year, but because owning a diversified portfolio of solid businesses is the time-tested method of building and protecting wealth. Hope that stocks will keep trending up is often futile, a belief that will always disappoint. But owning a diversified portfolio of great companies to build long-term wealth? That doesn’t disappoint.

…Except in the short term. Then you may find yourself haunted by hope’s evil twin: Regret.   As in “Why did I ever invest in the market to begin with?” or “Why didn’t I diversify outside the stock market?”  Through our time-consuming process of measuring your risk and quantifying your retirement needs, we have provided you with a comprehensive retirement plan…a blueprint that employs proven investment strategies, so you can have confidence in riding out the uncertainties inherent in the market.

In light of recent volatility in global markets and the steep sell-off of the past week, we want to share a few comments that we hope will prove helpful in gaining an understanding and some comfort.

  • A little perspective is always valuable.

It is worth noting that although the US hasn’t seen a stock market decline of 10% or more since 2012; in fact, 13 of the 17 years in the period ending in 2012 saw intra-year declines of 10% or more and the majority of those still finished the calendar year with a positive return. Although the VIX index (investors’ estimate of risk) has spiked to levels not seen since 2008, realized volatility measures (which are a more reliable indicator of market risk) are higher than they have been recently, but nowhere close to the levels observed in 2008 or even 2011.

In short, while our market indicators (as well as those of most of our tactical strategists) are elevated, they have not yet been triggered. For this reason, we are reluctant to characterize today as either a buying or a selling opportunity. Instead we believe the next few days, or maybe weeks, will tell us whether the future of market prices will be driven by fundamental values or by fear

  • In general, investors should not sell when a correction seems based on fundamentals.
    Historically, this type of decline has been limited in depth. In addition, fundamental corrections have tended to recover more quickly than the fear-driven market dislocations that take place when valuations become irrelevant and investor behavior is driven by anxiety.  At this time, markets have not become “irrational” in their pricing. While US stocks were down almost 4% for the day on August 24, the decline was much worse at the open before buyers who saw attractive valuations stepped in and brought the market well above its morning lows. 
  • Fundamentals still look promising for US and European economies.
    While the challenges faced by China and emerging markets more broadly will slow growth in developed markets, there is little reason to believe these challenges will result in a global recession. The US and European economies still appear poised for growth, albeit slow growth. In addition, market valuations appear reasonable and are now slightly below their historical average.
  • The Fed may clarify its position on interest rates, boosting investor confidence.
    Beyond China, another factor in domestic investor anxiety is uncertainty about a Fed interest rate increase in September and what impact higher rates might have on the stock market.  Last week’s sharp sell-off in the US and global equity markets may encourage the Fed to delay raising interest rates until December or March, since the rate hike is not necessitated by inflation but rather a desire by the Fed to reload some monetary ammunition to stimulate the economy in the event of an economic slowdown. An indication from the Fed that it will delay raising rates might motivate buyers on the sideline.  Conversely, even if rates rise, the certainty of the Fed’s move will provide investors greater confidence than the anxiety caused by the unknown.
  • Market volatility helps show the value of a managed, diversified portfolio of investment styles.
    The recent times only strengthens our conviction that diversified portfolios have higher likelihood of helping investors stay on track. History has shown us that the opportunity cost of not being invested in the market for long periods (waiting for the “all clear”) is far more costly than the losses associated with staying invested through a full market downturn like we are in.  It is for this reason that we recommend a portion of most portfolios be allocated to tactical strategies with a discipline for when to reduce and when to add back equity market exposure.  Similarly, many of our portfolios have an allocation in a managed futures strategy as this approach is among the few that have provided a reliable and effective hedge in the event of equity market dislocation.

As you have heard me say many times in the past, our investing process at Legacy Advisors is based upon the concept of diversification, which helps weather the storm. Not stock picking and certainly not market timing; that is the hallmark of “traders”, not investors like you.  Fear and greed keep us optimistic, but sober. Hope and regret will just cloud our thinking and cause our emotions to act against our own best interests.

If you have any questions or would like to discuss any of the topics covered in this review, as always, we encourage you to contact us.

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