Generally, I prefer not to comment on the markets when I search for a topic for my newsletter. I would rather leave that discussion to my meetings with clients. But the recent stock market turbulence and subsequent decline has left some clients a bit jittery. Due to the timing of the newsletter, I have decided to provide you with my analysis of the reasons for this volatility but more importantly, a long term perspective.
The bull market that may or may not have ended in October ranks as the fifth longest since 1928 and the longest running bull market since September of 1950. From its low in March 2009, the S&P 500 has almost tripled before retreating in September. It is interesting to note that many of the most significant market declines in history have occurred in September and October including Black Monday October 19, 1987, a day that many of us painfully remember. Despite a 22% decline that day, the market quickly rebounded and finished up for the year. As I write this piece in late October, the market has begun to recover some of the losses experienced over the past several weeks. While this rebound cannot portend performance through the end of year, it is helpful to view possible outcomes from a historical perspective.
This recent decline can be attributed to several factors, among them the renewed softness in Europe’s economy with a fear of recession, falling oil prices, geo-political events in Ukraine and the Middle East, and the threat of Ebola pandemic. Since many stock market analysts had already concluded that the US stock market was over-priced, the confluence of these events rattled the equities market. But the release of strong quarterly earnings by many US domiciled corporations has at least, temporarily, halted the decline.
While I do believe that the stock market may be a bit overpriced, it appears that there may be some justification for current valuations. Long term interest rates appear to be stalled at lower yields. In a low interest rate environment, stocks often serve as an attractive income substitute. However, there is one salient point that investors should always consider. Markets never go straight up. Whether the current turbulence represents a correction, bear market, or temporary respite from the long term bull market, we do know from history that a longer lasting decline is somewhere on the horizon. From a long term perspective, it is imperative to remain fully invested but to make allocation changes that can take advantage of lower stock prices. Many stock market watchers refer to this strategy as buying on the dips.
If an investor views the markets in the short term, it may be an opportune time to reduce allocations or even exit the stock market altogether. But for my clients who are long term investors, the appropriate strategy is buy, hold and tweak. By tweaking, I mean making tactical moves into pockets of opportunity. For example, many of you know that I have been slowly ramping up allocations to international equities. In particular, I have been closely analyzing opportunities in Europe and emerging markets. While the growth of Europe’s economy is probably 2-3 years behind the US, there are specific equities that are under-valued compared to their industry counterparts in the United States. And there are growth opportunities in emerging markets equities in countries such as Mexico and India where new political leadership is eliminating many of the barriers that impeded growth in the past.
It has been proven by financial scholars such as Jeremy Siegel that, over the long run, stocks will out-perform bonds despite greater volatility. I strongly adhere to this principle. When you add the ingredient of historically low interest rates that add little to portfolio returns, it is essential that long term investors maintain a strong allocation to equities. In my opinion, growth through equities investments is the key to generating sustainable retirement income. Investors should focus on the long term and not be detoured by the headlines of the day.
Clifford L. Caplan, CFP®, AIF®
Oops: In my last newsletter, I stated that the Medicare surtax and the tax rate for long term capital gains and dividends for certain taxpayers took effect this year. In fact, this change was effective in 2013. I should have made it clear that most taxpayers and their tax preparers began to deal with the effect of these increases this year as they prepared their 2013 tax return. I apologize for the misinformation.
In the News: On October 10th, I was quoted in a Wall Street Journal blog about my reaction to the turbulent stock market and what clients might expect in the future. Perhaps the most important point I made was my opinion that, for the foreseeable future, we have entered a low return environment that will be accompanied by greater volatility.