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Recent Market Volatility
There are many things that surprise us. The Eagles' win over the Patriots on Sunday was one of them. However, the recent volatility, and negative returns in the US stock market, are not a surprise, though they are disappointing. Although the timing and the trigger for volatility was always in question--- the fact that the market was high and frothy was something we've been speaking about for a long time.
Below are some thoughts we have been sharing with our clients directly. We thought our broader list of Market Digest readers might want to hear our take on the increased volatility we've seen over the past few days.
What seems to be driving this recent market dip?
- Fears about rising inflation--- driven by a solid jobs report and the assumption of faster wage growth
- Fears that higher inflation will cause a faster rise in interest rates, resulting in a bond market "crash"
- These two combine to raise a question about the future of corporate earnings, if wages are rising and debt payments are increasing. And corporate earnings, ultimately, support rising stock markets
- Rising deficits and the impact of higher rates on them
While we agree that these scenarios are all possible, none of these issues are surprising; in fact, we have discussed them all in recent Market Digests. So what's happening? In our
January 10, 2018 Market Digest, we discussed how market volatility (defined by the CBOE VIX index) dropped over 17% and saw 22 of its lowest 25 readings ever in 2017. At the same time, some measures of price (as expressed by Shiller's P/E) were the second highest in the last 80 years, as noted in our Market Digest of
March 8, 2017. (And prices only got higher from there.) Investors have been riding this market up and up and up, complacent and happy; but always with one eye on the exit. In our
Third Quarter 2017 letter to clients, and also during our Fall Strategic Decisions Luncheon, we discussed the various triggers that might cause a market drop. Higher inflation, rising rates and weaker corporate profitability were all good candidates.
So, the relevant question isn't "Why this recent volatility?" We believe it is far more important to ask "What should I do now?" Here are our thoughts.
Remember that as a client of New Market Wealth Management you are broadly diversified.
The time to shore up a home's foundation is before the storm hits. Trying to sturdy the home while the wind is blowing and the rain is falling is not good planning. Most of our clients have significantly less in stocks than when you joined us. This diversification was intended to mute clients' overall volatility and result in higher compounded returns over time. Even in the past few days, when all markets are down, our clients have experienced much less overall volatility.
Don't make any sudden moves
. Timing the market does not work, and will undercut your long term financial returns. Remember that for the 20 years ending December 2016 the US market lost more than 45% of its value on two separate occasions, yet compounded over the entire period at a rate of 7.7% annually. During this period, the average investor returned only 2.3% annually. We believe this was due to investors' natural (and unfortunate) inclination to get out when things are bad, and get in when they are better. Classic selling low and buying high.
Remember, you're going to be around for a long time. A 65 year old woman has a 73% likelihood of living 15 more years; a man has a 63% probability. And a couple age 65 has a 90% probability that one of them will. Additionally
--- for many of you
--- the true time horizon of your assets is the time horizon of your children and grandchildren.
You have the time to stay the course and benefit from the ability of markets to recover and surge ahead. Your finances will thank you for it. And, as the chart below shows, stock returns can be very volatile over a 1-year period, and losses can be significant. A balanced approach greatly reduces losses for even short periods, like a year. When looking at those longer-term periods, much like the time horizon of our clients, those volatile short periods have a much reduced impact.
Call us. If you're feeling uncertain or uneasy, give us a call. We can discuss these themes in greater detail, and put them in the context of your specific investments and goals. That's why we're here.
Important notes regarding the above exhibits can be found at the end of the Market Digest.
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Stocks experienced their first weekly loss of the year last week (and the pain continued into Monday of this week, with all the gains on the year being erased). Energy stocks led the market lower on Friday after weaker than expected earnings from ExxonMobil and Chevron. Healthcare also suffered after news that Amazon, JP Morgan and Berkshire Hathaway would team up to provide a healthcare system for their employees. But the markets were especially spooked by the positive jobs data issued on Friday. The tight labor market and increased cost of labor may give the Fed a reason to raise rates sooner and therefore may push the Fed to increase its pace of rate hikes.
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> Treasury Yields:
Yields have started 2018 off on a volatile note and the overall upward trend has been driven by multiple factors. Shorter-maturity Treasury yields have been pressured higher by rising Fed rate hike expectations. Longer-maturity yields have been driven higher by increasing concerns of a potential upside surprise to inflation and a move higher in real yields. But, while the recent move in yields has been sharp, it certainly has been muted relative to other sudden increases in yields.
> Healthcare Disrupted:
Last week we learned of an ambitious plan from three industry titans. Amazon.com, Berkshire Hathaway and JP Morgan Chase have teamed up to create a new firm with an "initial focus" on using technology to provide simpler, cheaper, and more transparent health care for their employees. Though details were light, healthcare stocks took an immediate hit. With nearly 1.2 million employees, hundreds of billions in combined revenue, and with the combined expertise of three of the most successful companies in history, those in the healthcare industry may have legitimate cause for concern.
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Science News: Concrete That Fixes Its Own Cracks
America's crumbling infrastructure--- from aging bridges to dangerous roads--- has been well documented. Solutions to the problem have been discussed in political circles, but now a group of researchers from Binghamton and Rutgers Universities have entered the conversation.
Many of our infrastructure problems can be attributed to cracks in concrete structures. As micro-cracks expand and reach the steel reinforcement, those metal structures can become corroded and lead to structural failure. Unfortunately, simply remaking the structure is just a short term fix until new cracks appear.
Binghamton University assistant professor,
Congrui
Jin, has been working on this problem since 2013, and recently published research that shows how a specific type of fungi can allow concrete to "self-heal" its own cracks.
When this fungus is mixed with concrete, it originally lies dormant, until the first crack appears.
When cracking occurs, water and oxygen find their way in, and the dormant fungal spores germinate, grow and precipitate calcium carbonate to heal the cracks. Once the cracks are filled in and no more water or oxygen can penetrate, the fungi forms spores and lays dormant until conditions are favorable again.
While more study is necessary, Professor Jin and her team see the potential to provide a low-cost, pollution-free and sustainable approach to America's infrastructure problem.
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Figure 1: The Average Investor
Indexes used are as follows: REITS: NAREIT Equity REIT Index, EAFE: MSCI EAFE, Oil: WTI Index, Bonds: Barclays U.S. Aggregate Index, Homes: median sale price of existing single-family homes, Gold: USD/troy
oz
, Inflation: CPI. 60/40: A balanced portfolio with 60% invested in S&P 500 Index and 40% invested in high quality U.S. fixed income, represented by the Barclays U.S. Aggregate Index. The portfolio is rebalanced annually. Average asset allocation investor return is based on an analysis by
Dalbar
Inc., which utilizes the net of aggregate mutual fund sales, redemptions and exchanges each month as a measure of investor behavior. Returns are annualized (and total return where applicable) and represent the 20-year period ending 12/31/16 to match
Dalbar's
most recent analysis. Source: JP Morgan; New Market Wealth Management.
Figure 2: Life Expectancy
Data based on the Social Security Adminstration Life Tables, 2014. Source: JP Morgan; New Market Wealth Management.
Figure 3: Time, Diversification & the Volatility of Returns
Returns shown are based on calendar year returns from 1950 to 2017. Stocks represent the S&P 500 Shiller Composite and Bonds represent Strategas/Ibbotson for periods from 1950 to 2010 and Barclays Aggregate thereafter. Source: Barclay's, FactSet, Federal Reserve, Robert Shiller, Strategas/Ibbotson, JP Morgam GTM and New Market Wealth Management.
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New Market Wealth Management offers modern investment solutions backed by extensive research and experience serving the needs of wealthy families. Through our strategic partnership with
Cliffwater LLC
, we have access to institutional-quality research, investment due diligence and asset allocation tools. We believe this level of experience and unique access to in-depth, sophisticated research are essential for success in today's complex world markets.
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Important