2022 May Stock Market Drop

The S&P500 has not hit the “20%” mark for a market correction but we have hit 14% drop since our last market high for the year. I wanted to provide you some analysis and commentary but ultimately we will want to remain patient and not attempt to time the stock market.

Early in the Year Market Declines “Feel” Worse

As of 5/5/2022, we are down 14% from our market high for 2022 and today (5-9-2022) is starting out rough as well. This decline feels more painful when it occurs at the beginning of the year vs later in the year. For example, 2018 saw a 20% decline most of which occurred in the last few months of the year. The market ended up down 6% in 2018 but most investors did not “feel the pain” as much as we do when the drop occurs early in the year.

Investors often feel that when January 1st hits, the returns earned previously are somehow “banked”, so a drop in the beginning of the year often causes more anxiety than a drop later in the year. When investors see a drop later in the year, they seem to feel some of that drop is “the house’s money”. We realize the fact that a loss is a loss regardless of when it occurs, but it is also important to understand this is human nature. It is perfectly normal for market declines earlier in the year to psychologically impact us more than declines later in the year.

How much does the market drop on average?

According to JP Morgan’s excellent “Guide to the Markets”, the market decline’s 14% on average in the last 42 years. The market still ended the year positive in 32 of 42 years.

Market intra-year drops of 14% on average despite positive returns 32 of 44 years

Perhaps one of the greatest examples is the decline in 2020 where the market dropped 34% in only a couple month when the pandemic hit. The market then proceeded to rebound rapidly to finish the year up 16%. Investors that sold even at half way down at 17%, still lost significant upside trying to time the market.

Is this time different? People around me seem really pessimistic?

Interestingly enough, pessimism tends to be good for stocks. If we look at this chart:

Consumer Confidence low is a good sign for future returns

According to the chart above, below average consumer sentiment is a good indicator for better future returns. The logic playing out here is that markets continue to drop as people/investors feel worse about the future. Once all the negativity and selling pressure has run its course, the market then can then rebound. One interesting thing to note is that sentiment is worse than even April of 2020 when the pandemic hit.

Rates are rising, Does that mean the stock market will tank?

Its possible but one of the interesting data points to look at is the following:

Stocks have generally performed well with rising rates as long as they were lower than 3.6%

A few things jump out at me about this chart. The first is that stocks have done well when rates were rising as long as the total yield was relatively low (3.6% since 2009 and 4.5% from 1965-2009). Currently, we are at around 3% for the 10 year bond. If we think the past 13 years or past 55 years are any indication, the current rising rates on the 10 year bond should not choke off stock market growth.

Further, we can look at past rate hike cycles:

Market has averaged 5.8% in tightening cycles

If we look at the past 7 rate hike cycles, the market on average ended up 5.8% and ended up positive in 4 out of 7 cycles. The moral of the story: there is not a convincing enough argument to try to time the market based on Fed tightening.

What about the “I” word…… Inflation?

Inflation has roared ahead dramatically since mid 2021 with the most recent numbers from March of 2022 being 8.6%.

Inflation on a comeback

While food and core CPI are higher than the 50 year average, energy has been dramatically higher at 32%. Energy is notoriously volatile but current pace is increasing quickly. While energy inflation is a concern. The biggest concern from the Fed when they raise rates are wages.

Unemployment at extreme lows and wages are growing rapidly

Unemployment is the lowest it has ever been. Wonder why McDonald’s is advertising for jobs in the drive thru? They are desperate for help. The lack of labor available has caused a run on wages with wage growth growing very quickly.

The Federal Reserve is the most concerned about historically low unemployment and wage pressures more than other items affecting the inflation.

The Federal Reserve has a dual mandate. The Fed reserve seeks to keep unemployment low and keep prices stable. Currently, we have prices increasing rapidly with ultra low unemployment.

Do not let the short term ruin your long term investing plans

This mantra has been my consistent advise to clients that have worked with me over the years. It is very challenging but we need to make sure we do not let short term movements affect our long term plans. I will leave you with a few charts to explain why we need to stick it out with our long term plans.

The average investor (many of which have investment advisors) have underperformed nearly every asset class. How does that happen? Investors try to time the market and jump in and out of different investments at the wrong time. Had the investor simply picked ANYTHING other than commodities, they would have performed better. Moral of the story, stick with our plan and try not to time the market and jump to the latest fad.

As can see from the above chart, our greatest ally is time. We need to be patient and let the 5 and 10 year returns reward us. Diversified portfolios over 5 and 10 year periods are overwhelming positive. While past returns do not guarantee future results, I do think the wise investor should find comfort in their long term goals matching with the markets long term returns.

Ultimately, we need to stick to our long term plan.  It will be nearly impossible to time the next big drop in the stock market.  Should we try, we are more likely to make the call incorrectly and hurt our long term returns.  Attempting to time the stock market is similar to the old “Siren’s song”  longing boats to veer off course and into trouble.  I remain vigilent and will continue to position our portfolios to withstand market jitters and help us reach our long term goals.  If you have any questions, please do not hesitate asking.

I will leave you with the last few times we had similar articles to reassure you that these drops are common and more times than not, they are not signs of worse things to come.

https://investwithsteve.com/2018/02/2018-stock-market-jitters-time-panic-relax/embed/#?secret=bVUGNrwr0S
https://investwithsteve.com/2015/09/mythical-bears-and-more-stock-market-reflections/embed/#?secret=UJMuNZjXQU
https://investwithsteve.com/2015/09/2015-q3-stock-market-2011-again-or-2008/embed/#?secret=VwwDGqDf38

PLEASE DO NOT HESITATE CONTACTING ME IF YOU HAVE ANY QUESTIONS.

** The information on this website is intended only for informational purposes. Investors should not act upon any of the information here without performing their own due diligence. Reh Wealth Advisor clients should discuss with their advisor if any action is appropriate.

Alot of the slides were take from

https://am.jpmorgan.com/us/en/asset-management/gim/adv/insights/guide-to-the-markets

Small Business Help – EIDL and PPP

There are two programs for small business owners, the EIDL loan/grant and the PPP (payment protection plan) loan. Both offer assistance for small businesses. Information is coming out rapidly and the details do seem to be changing slightly as it comes out.

EIDL – Economic Injury Disaster Loan

This loan is taken out directly from the SBA and this is one of the better summaries I have found:

https://www.investopedia.com/how-to-apply-for-an-economic-injury-disaster-loan-eidl-and-loan-advance-4802134

You can also apply for it here:

https://covid19relief.sba.gov/#/

EIDL mainly required businesses to have less than 500 employee and the corona virus has qualified the location for all 50 states. In addition to employer (corporations) it also includes:

  • Sole Proprietors
  • Independent Contractors
  • and Self Employed people

Approval conditions:

  • Borrow up to $200k without personal guarantee
  • 1st year tax return not required, can borrow based on credit score
  • Do not have to prove you cannot get loans elsewhere
  • $25k or less loans require no collateral
  • Must allow SBA to review tax records

The biggest benefit was the $10k advance that would be a grant and should arrive within days of filling out application. Unfortunately, at this time, it appears that the SBA has been overwhelmed and they are running slow getting them out.

Further, I have found there appears to be some changes coming about based on this story of limiting the 10k to 1k per employee with 10k as the max.
https://www.inc.com/kevin-j-ryan/small-business-loans-eidl-advance-limitations.html

PPP Loans – Paycheck Protection Program

Here is the Fact Sheet from the US Treasury covering the PPP Loans

https://home.treasury.gov/system/files/136/PPP–Fact-Sheet.pdf

Highlights, 1% fixed rate loans for small businesses. All Loan terms are the same for everyone.

Loan amounts can be forgiven for:

  • The loan proceeds are used to cover payroll costs, and most mortgage interest, rent, and utility costs over the 8 week period after the loan is made; and
  • Employee and compensation levels are maintained.
  • Payroll capped at $100k for each employee.

The funds are run through SBA Lenders (your typical banks and credit unions usually). The tricky part is that it appears the banks are only helping their current customers.

If you think either program may apply or help you. Please contact me and we can review your situation.

** The information on this website is intended only for informational purposes.  Reh Wealth Advisor clients should discuss with their advisor if any action is appropriate.

Cares Act

Congress has passed the Cares Act. (link below to full text)

https://www.congress.gov/bill/116th-congress/senate-bill/3548/text

  There are many items that could affect you and I will be crafting a longer analysis of items that may impact you and those you know.  Here are some highlights:

1) Individuals making under $75k AGI in 2019 will received $1,200 payment, married couples under $150k will receive $2,400.  An additional $500 for each qualified child.

2) Elimination of 10% early withdrawal penalty for distributions from retirement accounts related to the Corona Virus.  Can be repaid back into the retirement accounts over 3 years.  Income tax may be spread over 3 years as well.

3) It appears all RMD’s from retirement and beneficiary IRA’s have been suspended.  It also appears you can give back distributions taken already this.  I will be confirming these details.

4) Unemployment increased $600 over normal state unemployment.  Benefits available without waiting the normal 1 week period.

5) Additional benefits for small businesses such as loans at maximum 4% interest, potential tax credit, and potential deferring of payroll taxes.

For those looking for additional reading, the best resource I have found so far is here:

https://www.kitces.com/blog/analyzing-the-cares-act-from-rebate-checks-to-small-business-relief-for-the-coronavirus-pandemic/

Kitces’s intended target market is investment advisors so his articles tend to be technical in nature.

Please do not hesitate reaching out to me with any questions and please do not act without discussing it with a financial advisor.

Thanks,

Steve Reh

Corona Virus – Market Update

Today saw the largest one day drop since 1987 as fear of the corona virus hit the markets. Most market indexes are now down 20% from their high which is what qualifies as a market correction. In 1987, the market dropped over 22% on what is referred to as “Black Monday”.

When Was the Last Market Correction?

Our last market correction of 20% occurred less than 2 years ago in the second half of 2018. It was not as fast as this most recent drop, but markets recovered very quickly in 2019.

Wait, why are some outlets saying we haven’t had a correction since 2008?

I really do not know. They seem to be ignoring the definition of a market correction which by definition is a drop of 20%

How Quickly did we recover from 2018’s Drop?

By April of 2019, the S&P500 had fully recovered from the 20% drop that occurred from late August through December of 2018.

Source: https://en.wikipedia.org/wiki/Closing_milestones_of_the_S%26P_500

Do you see any other times in history that might be a guide?

I do see some parallels with 9/11 in that the world as we previously knew it seemed to be changing and we faced fears we had not seen before.

Due to fear and concerns over the financial firms inside the World Trade center the stock market stopped trading until 9/17. The NY stock exchange opened on 9/17 with a 7% loss and continued to lose over 14% for the week. It was one of the largest 5 day losses the market had seen.

Less than one month later the stock market had regained its pre 9/11 levels

https://www.investopedia.com/financial-edge/0911/how-september-11-affected-the-u.s.-stock-market.aspx

What if we have another 2008?

What do I mean by 2008? I mean another “worst stock market of our lifetime” period. How long did it take to recover from the 2008 stock market?

The recovery came swift and a return to value

  • 40% stocks/60% bond portfolio recovering by November 2009
  • 60% stocks / 40% bond portfolio recovering fully by October 2010
  • The 100% stock S&P500 recovered full by March 2012

The Takeaway

Time periods like we are experiencing now are very challenging for investors. Time periods such as we are in now are tempting to feel that there is no relief in site. However, looking at history, we can see that the stock market, our economy, and country have recovered from even the worst of time relatively quickly. Its persisting through times such as we are in now that allows up to capture the upside of investing. Market timing is tempting and “feels right” when times are rough, however, research has shown us that market timing is extraordinarily difficult (need to be correct over 70%-80% of the time) and in most cases, trying to time the market has hurt our portfolio returns. We are reminded of the “average investor” returns the past 20 years from this slide:

Had the average investor since 1998 simply picked any other the other asset classes and stuck with it, they would have performed better. Further, they did not even outperform inflation.

I will continue to be vigilant in monitoring your portfolios and to ensure we are acting in prudent matters. Please do not hesitate contacting me if you have any questions.

2020 Corona Virus Market Correction

The corona virus continues to dominate the financial press and has resulted in one of the fastest 10% drops in the stock market that we have seen. While its been fast and furious, I think its important to remember that throughout history the patient investor has been rewarded for taking risk and staying in the market.

The Average Drop in any given year from the market high is 13.8%

As the chart above shows, in any given year we see an average drop of 13.8% from the market high. Even with the recent 10% drop the S&P500 quickly saw. We still have not gone beyond a “normal” stock market pull back. While it can be difficult its important to remember the patient investor is rewarded.

While less common, we can see market corrections of 20% like we saw near the end of 2018. Investors that were patient and stayed invested, enjoyed a great 2019.

It has Always been a bumpy ride even when hindsight feels smooth

The past run since 2008 has survived:

  • Muni Bond “Crisis” – some analysts were calling for massive losses in the municipal bond market and that it would not only hurt the bond market but would hurt equities. Neither the bond market or stock market sufferred and its been a long time since we have heard concerns about massive amounts of muni bond defaults.
  • Greece’s Economic Mess would take down Europe and the US would follow – The market dropped in 2011 but it was short lived and the market continued its climb
  • War on terrorism
  • Previous Epidemic Scares
    • Swine Flu in 2009
    • Cholera in 2010
    • MERS in 2013
    • Ebola in 2014
    • Measles/Rubeola End of 2014 Early 2015
    • Zika Virus at Olympics in 2016
    • Measles/Rebeola 2019

Previous Epidemics have had minimal long term impacts on the Market

You can read the article I wrote a few days ago which discusses the previous impacts of epidemics here:

Doing the “Right” thing feels a little wrong

There is a temptation to “do something” despite research showing us that time and time again, the best advice is to persevere through market pull backs and corrections. Trying to time the market is paved with people that have failed attempting to do so. Here is a quick reminder of the rewards of sticking to our model and long term plan:

This chart from JP Morgan shows us a few things. The Average investor under performs nearly any asset class over the past 20 years. The only way the average investor can under perform nearly every investment is by market timing or by jumping from one fad to the next. Had the investor stuck with a 60/40 portfolio they would have earned over 3% higher returns. Bear in mind the past 20 years from 1998 to 2018 are starting at nearly the peak of the dot com bubble. So the returns are inclusive of both the dot com bubble bursting and the financial crisis.

The next thing to remember is that 2008 was the worst stock market of our lifetimes. However, the recovery came swift and a return to value

  • 40% stocks/60% bond portfolio recovering by November 2009
  • 60% stocks / 40% bond portfolio recovering fully by October 2010
  • The 100% stock S&P500 recovered full by March 2012

A Reminder not to let short term results impact your long term plan

Its often easy to say that we should invest for the long term and stick to our plan. However, once we are in the middle of a market correction, it can be challenging. Here is a reminder of the article I sent the last time the market dropped 20% in 2018 before having a great 2019:

Clients should not hesitate reaching out to me to schedule a meeting or call. I am here and working on helping you reach your financial goals.

** The information on this website is intended only for informational purposes.  Reh Wealth Advisor clients should discuss with their advisor if any action is appropriate.

Corona Virus – History Lesson

Today (2/24/2019) the Corona Virus impacted stock markets driving market indexes down more than 3%. Fears of the impacts of the virus results in a relatively large one day drop for the stock market. I wanted to review past Epidemics to help calm investors and understand the risks to their portfolios and the most prudent action going forward.

Is it Time to Panic?

The simple answer is no. The panicking investor has rarely been rewarded. Right now is the time to look at history and review the results. Market Watch has a great article that shows the past results of similar health scares. https://www.marketwatch.com/story/heres-how-the-stock-market-has-performed-during-past-viral-outbreaks-as-chinas-coronavirus-spreads-2020-01-22

Past History lessons of Health Epidemics with the US Stock Market

EpidemicMonth end6-month % change of S&P12-month % change of S&P
HIV/AIDSJune 1981-0.3-16.5
Pneumonic plagueSeptember 19948.226.3
SARSApril 200314.5920.76
Avian fluJune 200611.6618.36
Dengue FeverSeptember 20066.3614.29
Swine fluApril 200918.7235.96
CholeraNovember 201013.955.63
MERSMay 201310.7417.96
EbolaMarch 20145.3410.44
Measles/RubeolaDecember 20140.20-0.73
ZikaJanuary 201612.0317.45
Measles/RubeolaJune 20199.82%N/A
SourceDow Jones Market Data

Note: I borrowed that table and information from the marketwatch article.

As we can see of the 12 previous epidemics, only one had a 6 month negative return for the S&P500 (HIV/AIDS 1981 0.3% Loss). Only two epidemics had negative returns over the next 12 months (HIVE/AID 1981 16.5% loss, and Measles/Rubeola 2014 with a nearly flat 0.73% return).

World Stock Market Impacts

Great Chart from the Market Watch Article

The above chart I also took from the market watch article. This chart shows the world market return as many of these epidemics started outside the US. As expected, the performance was worse than the US market, however some interesting findings are there.

  • Average returns are not just positive over the 1 , 3, and 6 month periods, the 6 month average return is an impressive 8.50%
  • 9 of 13 periods showed a loss over a 1 month period
  • 4 of 13 showed a loss over a 3 month period
  • The same 4 epidemics showed losses over the 6 months period, with losses of 3.25%, 4.30%, 0.57%, and 3.49%. In all cases, these 6 month losses are fairly tame.

Conclusion – Epidemics historically have had minimal risk to portfolios

While its always possible “this time is different”, history has show us that epidemics are likely the least cause for worry for our portfolios. The fear is that we could have another black plague that devastated Europe and Asia in the 1300s that killed 20 million people in Europe (1/3 of the population). However, modern sanitation and public health practices has mitigated the black plague. The combination of modern medicine, health practices, and modern sanitation greatly reduce the odds of another mass plague.

So while the Corona Virus is scary, the odds are your portfolio should weather this threat well. While we cannot predict the future and the risk that “this time is different”, the past epidemics in modern times have had minimal impact on portfolios. As is usually the case, maintaining market risk/exposure is the prudent course of action and the calm/patient investor will most often be rewarded.

** The information on this website is intended only for informational purposes.  Reh Wealth Advisor clients should discuss with their advisor if any action is appropriate.

Secure Act Summary

In the closing months of 2019 Congress Passed the Secure Act and it has some relatively large impacts on retirement savings and retirement plans going forward. I have read several articles digesting the impact of the act but I think Fidelity has put together the best article that details the impacts fairly well.

Secure Act – Fidelity’s Article here

https://www.fidelity.com/learning-center/personal-finance/retirement/understanding-the-secure-act-and-retirement

Secure Act – High Level points:

  • Require Minimum Distribution Age has been changed to 72 from 70.5
    • This only impacts those that have not started RMDs. Those who started RMD’s in 2019 will need to continue to do so even if they are younger than 72
    • As a reminder this is the age you MUST start taking distributions from your retirement accounts that are tax deferred (Roth’s are post tax and are not subject to RMD’s as of the time of this article).
  • Removed the age limit on Traditional IRA contributions (still required earned income)
  • If you worked part time > 1000 hours in one year or > 500 hours over 3 years, you are now eligible for your employers 401k.
  • Parents can withdraw Penalty free up to $5k from retirement accounts the year of a child’s birth or adoption
    • NOTE – This will still be subject to income taxes
  • Basically killed the “stretch” IRA. If someone inherits an IRA that is a non-spouse, funds must be distributed and pay tax with 10 years
  • Added a tax credit for small businesses starting a retirement plan
  • Allows up to 10k to be distributed from a 529 plan to pay down student debt.

If you have any questions on how this may apply to you, please do not hesitate contact me. Please note that the information from this post is meant to be educational and should not be considered advice. Clients should contact me to receive specific advice on your situation.

Schwab Acquiring TD Ameritrade

TD AcquiresSchwab

Schwab Acquiring TD Ameritrade

The Quick Summary of Impacts to TD Clients

  • Minimal impact for the next year
  • Costs are unlikely to change
  • It does not appear any new paperwork will need to be done
  • New competition will keep pressure on costs even with TD/Schwab size
  • We use TD because they provide great service for a great price. If the Schwab does not continue to provide great service and value, we have other options

Longer Version

TD Ameritrade and Schwab have announced intentions for Schwab to acquire TD Ameritrade.  I do not see a huge difference that will impact any of the experiences my clients face as a result of this merger.   My concerns are more that two of the largest discount brokerages are combining forces and I wonder what the impact will be for consumers in general.

Pricing Competition has been good for us

TD Ameritrade and Schwab have both reduced transaction fees for stocks and ETF’s to zero which has been great for consumers.  The competition between them has been great for the consumer.

The reduction to zero was not a result of TD and Schwab competition. A new upstart called Robinhood was the putting pressure on the discount brokerage houses like TD and Schwab so they really had no choice but to match.  Schwab dropped prices at first then TD followed.

What has past acquisitions taught us?

We can also look at past history.  TD was the result of a merger between Ameritrade and TD Waterhouse.  After the merger we have only see cost for financial transactions decreasing and we will likely see that continue.  When Scottrade and TD combined, we did not see costs increase in the industry either.

There are still other competitors and new ones entering the industry

On the RIA advisor custodian side (brokerages that work with firms that are independent Registered Investment Advisors), we are seeing the two largest RIA custodians combine and that competition reduce.  However, E-Trade has been growing their advisor solution and there are rumblings of Vanguard also re-entering the space.  The end result will hopefully be continued competition which is good for all.

Minimal Impact for us

At this time, I do not see merger being bad or good news.  I never like to see our choices or options reduce.  I have also spoken with TD and they have told me the combined Schwab and TD firm is committed to serving advisors like me and my clients.

You are unlikely to have to redo account paperwork (Scotrade clients did not need to “repaper” accounts).   After the acquisition completes, you will likely have to use Schwab’s client portal and will start receiving statement that say Schwab instead of TD Ameritrade on them.

If you have any questions or concerns please do not hesitate reaching out to me.

Market Correction – Do Not Let a Market Drop Ruin Your Long Term Investment Plan

The S&P500 has now officially dropped 20% from its market high. It has exceeded the 14% on average drop. Its now officially a correction. I have said multiples times over the past 10 years that most pullbacks are temporary and we should not try to time the stock market. That has proved wise as we experienced a 16% drop in 2010, a 19% drop in 2011, a 10% drop in 2012, 12% drop in 2015, 11% drop in 2016. Each of those times, we were better off assuming things would not get worse.

Last September/October when I wrote that we need to be patient as the drop in the market could be a false alarm as it was the previous times. This time was indeed different and the market dropped quickly in December of 2018. So now, what do we do?

Market Drops from 1980 Through 2018
Market Drops 1980 to 2018

Source: https://am.jpmorgan.com/us/en/asset-management/gim/adv/insights/guide-to-the-markets

Too Late Market is ALREADY predicting a minor recession

The stock market is a LEADING indicator for the economy. The economy currently as of today, is still showing strength. Unemployment is low and earnings are up. Why is the market dropping then? Future expectations is the answer. With rising interest rates from an aggressive Fed, “the market” is predicting that the economy will worsen and earnings will drop and unemployment will get worse.

Previous Recessions / Bear Markets

Previous Bear Markets and Recessions
Previous Bear Markets and Recessions

Source: https://am.jpmorgan.com/us/en/asset-management/gim/adv/insights/guide-to-the-markets

As you can see from the chart above, there are some examples where the markets sold off even more than what we have seen.

Great Recession of 2008- a 57% drop
Early 2000s (dot com bubble bursting) – 49% drop
Recession of 1973 – 48% drop
Recession of 1969 – 36% drop

We also had a couple of non-recession bear market drops of 28% and 34%.

Realistically, I think the Great Recession and the Dot Com bubble bursting were two historic events that are likely outliers. Which means if we use history as our guide, we are at a 20% drop and may have some room to drop further but we have likely already seen the worst of it. Is it possible it drops another 30%? Yes but I feel its less likely that being less than 10%.

Market Could Recover at any moment but the longest it should take until the drop stops within 1-2 years of starting

The market hit its most recent high as of August 29th 2018. If we look at the previous chart, most drops end within a year and nearly all within 2 years (dot com bubble lasted a little longer). We are already 3-4 months into this drop. The market could recovery at any moment and return to positive returns. The valuations currently look better than they have for years.

For those arguing that “I don’t have time to make up if it drops more”, even if it lasts on the long side at 2 years, you still are not drawing the majority of your portfolio within the next 2 years. You can wait this out and you will likely be better off for it as when you exit the market, then you will be faced with a tough decision of when do you re-enter. Its important to understand the reversal can come at ANYTIME within 2 years. It could have already started the recovery and we don’t know it yet. When markets reverse from a downturn, they often reverse VERY quickly and experience the largest gains in the beginning when many doubt whether the recovery is real.

Where are Valuations Now?

Most metrics show valuation are undervalued

Looking at the above chart from JP Morgan we can see the past 25 years this market drop has made several measures report that the market is now undervalued. Foreward P/E, Dividend Yield, Price to Book, and earnings yield less Baa bond yield all show a market that is undervalued relative to the 25 year average. The only metric showing the market might be slightly overvalued is the Shiller P/E ratio which uses 10 years of earnings data so its tells us less about where we are now and more about how the past decade compares.

On the whole, I feel better about the valuations of the market than I have in a long time. Bear in mind, these numbers indicate that either 1) market will go up or 2) that a recession is coming and fundamentals will deteriorate relative to prices.

What do we do?

I hate to say nothing but the most prudent action is to review our risk allocations and make sure our portfolios still meets our investment objectives. Valuations look very attractive currently and I do think the outlook for the market is better than it was 1 year ago. It may sound odd but the 20% drop is HEALTHY for the stock market. It reminds investors there is risk that goes with reward.

The market has survived much worse times than the ones we are facing now and it will survive this one as well. The most difficult and critical component to success will be sticking with a long term investment plan and not letting market corrections derail the success of your plan.

I will continue to work hard for you to help you reach your goals and perform actions that are supported by research to help you continue to make good decisions with your finances.

2018 Stock Market Jitters Part Two

2018 Market Jitters Strikes Again

 

Market Jitters are back.  The stock market pulled back strongly the past few days as shown in the following chart.

SP500 Chart October 2018 ytd
SP500 Chart October 2018 ytd

 

 

What is happening and should we be concerned?

 

Corporate Earnings Growth Has Increase Dramatically

Earnings per share (EPS) has averaged 6.9% from 2001 through 2017.  In the first and second quarter of 2018, EPS grew dramatically at 27%.  The growth was a combination of both better margins and higher revenues.

 

 

Wait, Is Earnings Growth Bad?

No growth is not bad.  However, when earnings grow quickly it raises concerns about inflation.  Bond investors seeing that growth became fearful of inflation started selling off bonds.   The 10 year treasury bond increased very rapidly. (Chart below shows yield increase on 10 year bond from 3.05 uo to nearly 3.250 before decreasing as stocks sold off).

 

Higher Bond Yields Bad for stocks

Stock investors seeing yields increase rapidly became fearful that the higher yields would cots businesses more money and hurt earnings.   The argument goes that higher yields increase business’s borrowing costs which in turn hurt earnings as expenses are higher than previously due to the debt.

This increase in yield drove the stock market lower as investors felt higher yields would be bad for future returns of stocks.

 

Is this a small bump or a sign of things to come.

For those that have read my analysis for years, probably already know my answer.  It is VERY difficult to predict if there will be a bigger drop.  If you just bet “no” and that it was a bump is the road, you would be correct the majority of the time.  Every year, the market drops on average almost 14% from the market high and every drop feels like we will go further into recession.  At some point, it will not be a false alarm and will be a real drop.  However, we will likely not know it until it is over.  Trying to predict the next prolonged drop would have cost us dearly the past 10 years as the market quickly recovered several times.

 

 

 

Intra Year Stock Market Declines
Intra Year Stock Market Declines

 

Ok, Steve, We will not panic and we will not be tempted to try to time the stock market.  What else can you tell me right now?

 

One interesting thing is that history tells us that when yields have been below 5%, an increase in yields has generally been correlated with positive stock market returns as shown by this chart:

Rates and Market Return Correlations
Rates and Market Return Correlations

 

Does this make sense?  It does  when rates have been below 5%, we typically have been coming out of a period of low rates.  Rates would be increases as a response to growth and in general, growth is good for the stock market.    When rates are above 5%, that has historically been during times where growth was too hot and inflation was a problem.  So rates were raising indicating an overheating  economy with runaway inflation or as was the case in the 1970s, runaway inflation with stagnant growth (stagflation).

What if it does get Worse!  How bad is it going to be!

First, I really don’t know.  However, let’s get some context and see what previous recessions have looked like.

 

Recessions
Recessions

Many are quick to assume we will see a 50%-60% drop in the stock market similar to the Great Recession (Financial Crisis of 2008) or the dot com bubble bursting of the early 2000s.  However, those two recessions we more anomalies than the norm.  The dot com bubble was the recent of irrational exuberance and extreme valuations for stocks and the financial crisis was driven by the fear of our financial system collapsing due to banking risk in mortgages and derivatives based on mortgages.    Both events tended to be anomalies in market history.  Therefore, I feel we are much more likely to see a 15-30% drop than a 50-60% drop.  I would also expect diversified portfolios similar to what I use to go do much less that the 100% stocks, S&P500.  So a diversified portfolio dropping in the 8% – 20% range is more likely in my opinion that the large drop we saw in the financial crisis of 2008.  So while I can’t guarntee we will not have another 2008, I do think its more likely if we have a further drop, it will more likely be similar to our more tame recessions.

 

What Should We Do?

Ultimately, we need to stick to our long term plan.  It will be nearly impossible to time the next big drop in the stock market.  Should we try, we are more likely to make the call incorrectly and hurt our long term returns.  Attempting to time the stock market is similar to the old “Siren’s song”  longing boats to veer off course and into trouble.  I remain vigilent and will continue to position our portfolios to withstand market jitters and help us reach our long term goals.  If you have any questions, please do not hesitate asking.

 

I will leave you with the last few times we had similar articles to reassure you that these drops are common and more times than not, they are not signs of worse things to come.

 

PLEASE DO NOT HESITATE CONTACTING ME IF YOU HAVE ANY QUESTIONS.

** The information on this website is intended only for informational purposes. Investors should not act upon any of the information here without performing their own due diligence. Reh Wealth Advisor clients should discuss with their advisor if any action is appropriate.

Alot of the slides were take from

https://am.jpmorgan.com/us/en/asset-management/gim/adv/insights/guide-to-the-markets

and

https://finance.yahoo.com

and

https://finance.yahoo.com/