Yesterday’s market action continued what has become an especially weak month of October for stock markets around the globe.
Rising interest rates in the United States, fears over global growth slowdown, the potential for a U.S. recession sooner than previously expected, geopolitical risk including in Saudi Arabia, and concerns the upcoming mid-term election may result in a political surprise are some of the factors attributed to the recent decline.
Market pullbacks are not a time to panic, and instead should be used as a reason to analyze current positioning and assess potential opportunities and risks. While some pullbacks lead to deeper declines which must be protected against, others represent attractive buying opportunities.
While only hindsight will allow us to reflect on the current downturn, we wanted to share with you some of our thoughts as of this morning.
Abnormally Low Volatility
During the current bull market, we have seen very few meaningful market drawdowns. In fact, there have only been three times the S&P 500 has declined ten percent or more in the last five years: fall 2014, January 2016, and February 2018. The lack of market volatility has in fact been abnormal, and it appears we are quickly returning to more historical norms as we sit amid the second meaningful selloff of 2018.
We thought it would be helpful to put “normal” market volatility in perspective by looking at market declines since 1945.
As the chart above shows, the majority of market declines fall within the 5-10 percent range, with an average decline of 6% occurring on average at least once annually. 10-20 percent declines are not uncommon, the last decade notwithstanding, and have occurred frequently during normal market cycles. Major declines of 20 percent or more have occurred only 11 times in the last 70 plus years. So, the question must be asked, is this a “normal” pullback, or are we headed for something more significant?
We believe the answer is the former: while not typical of the current bull market, declines of approximately 10 percent in magnitude are normal and have actually not been happening as frequently as they should, creating a false sense of actual stock market risk. Our conviction in our belief that this pullback will not grow to something significantly more meaningful lies in history which shows that most pullbacks of 20 percent and all pullbacks of 40 percent have been associated with economic recessions. Economic conditions in the U.S. largely remain positive, and leading economic indicators suggest the next recession is likely to occur sometime in 2020 at the earliest.
One big caveat to add to the above discussion about “normal” and healthy “corrections” that investors may not be aware of is the increase in algorithmic trading programs by investors large and small in recent years. In fact, some sources attribute as much as 60-70% of daily trading volume to algorithms, momentum, and program trading. We believe this is a contributing factor to stocks that at times are rising parabolically (volatility investors enjoy when going almost straight up) but adds to a waterfall effect when investments are cascading to the downside. While volatility is normal, it certainly does not feel like it because of such sharp moves up and down. This is, of course, more unnerving on down days and is something to be aware of.
Putting Pullbacks in Perspective
At Republic, our focus has always been and will continue to be on downside protection. In our opinion, limiting severe losses is the single biggest factor in achieving long-term investment success. Due to the speed with which this selloff has occurred, we have thus far chosen to largely maintain equity existing exposure (selling now may feel good, but we want to do our best to avoid selling at a market low). Many portfolios have some cash allocation, and we have taken defensive action by raising cash in some client portfolios. Diversification through positions in alternative investments, cash, and fixed income has served to buffer equity market downside. Most importantly, we continue to evaluate conditions daily and are prepared to take further action should conditions continue to deteriorate.
Re-Assess Risk Tolerance
The current selloff presents the ideal opportunity for you to review your risk tolerance as only in the middle of a pullback are you able to effectively evaluate how much risk you can actually tolerate. Is the current decline making you feel uncomfortable? As indicated above, the current 10 percent decline should be expected to occur regularly, so now may be a good time to re-assess your risk tolerance.
We are reminded during periods like the present that while riding through volatility of markets is never fun, if we are not likely to experience a significant decline of 20% or more, staying the course in time has proven the best course of action.
We remain confident in your investment strategies and will continue to monitor progress toward your financial objectives. Don’t hesitate to reach out by phone or e-mail if you would like to discuss your specific situation in greater detail.
IMPORTANT DISCLOSURE INFORMATION: Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by Republic Wealth Advisors), or any non-investment related content, made reference to directly or indirectly in this blog will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this blog serves as the receipt of, or as a substitute for, personalized investment advice from Republic Wealth Advisors. To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing. Republic Wealth Advisors is neither a law firm nor a certified public accounting firm and no portion of this blog content should be construed as legal or accounting advice. If you are a Republic Wealth Advisors client, please remember to contact Republic Wealth Advisors, in writing, if there are any changes in your personal/financial situation or investment objectives for the purpose of reviewing/evaluating/revising our previous recommendations and/or services. A copy of the Republic Wealth Advisors’s current written disclosure statement discussing our advisory services and fees is available upon request.