RECENTLY, A STRONG AND RELATIVELY CALM BULL MARKET HAS GIVEN WAY TO AN INCREASE IN VOLATILITY AND DECLINE IN VALUE WHICH HAS RESULTED IN RENEWED ANXIETY FOR INVESTORS.
While it may be difficult to remain calm during such periods, it is important to remember that volatility is a normal part of investing. Further, for long-term investors, reacting emotionally to volatile markets may be more detrimental to portfolio performance than the drawdown itself.
Market pullbacks are far more common than most investors realize. According to Capital Research and Management (see attached chart), intra-year declines of 5% or more happen about 3 times per year, declines of 10% or more happen about once per year, declines of 15% or more happen about once every 2 years, and declines of 20% or more happen about once every 3 ½ years. Further, intra-year declines have averaged 13.4% since 1948, yet calendar year returns have been positive in 51 of those 70 years. In 2018 the biggest intra-year decline so far is from the high reached on January 26 to the low reached on March 23, a decline of 11.6%. That decline is the first of its kind since 2016. As we have been saying in our review meetings, we had gotten conditioned to abnormally low volatility with strong returns and the equity market was overdue for a correction. Even so, this 11.6% intra-year decline is still less than the historical average intra-year decline of 13.4%. Surprisingly to most investors given how this market feels, as of the market close on April 6, 2018, the S&P 500 is down only 2.9% for the calendar year 2018 (Wall Street Journal, April 6, 2018).
One new factor pressing on markets this year is the trade talks with China, and many investors are concerned about how that might affect the US economy. To put it in perspective, consider that the United States exports roughly $130 billion per year to China, and the US economy is approximately $20 trillion in size, so our exports to China are roughly 7/10 of 1% of the US economy (Ladenburg Thalmann: Potential implications of a trade war). This is an amount so relatively small it is beyond economists’ capability to accurately measure. Said another way, if all the trade with China disappeared tomorrow, we might not be able to measure its effect on the US economy, and in a quarter or two we wouldn’t even know it happened since internally generated growth is so much more important than anything China contributes. Our opinion is that this is simply positioning by both sides at the outset of tough trade negotiations which will eventually result in a new trade arrangement that will benefit the US economy in the long run.
Going forward it’s important to focus on the economic fundamentals of the US economy which we believe are robust. The stock market’s price/earnings ratio is now very close to the historical norm (meaning stocks are not overvalued), corporate earnings are great and will have a healthy dose of stimulus from the tax cuts passed late last year, interest rates are still near historical lows, inflation is tepid, the job market is very healthy with essentially a job available for anyone who wants one, and wage growth is accelerating.
To summarize, it’s never fun to experience volatility and market declines but we believe this is a healthy correction, the fundamentals of the US economy remain strong, there’s no recession in sight, and the China trade negotiations will ultimately be resolved in a way that is beneficial to the United States. We think these conditions should bode well for equity markets in the US over the long term.
If you have any questions or would like to discuss further, please feel welcome to let us know.