If you are not already one of the people asking me, “What do you think about the rest of the year,” it is likely you will have it at the top of your list of questions when we speak next.
I want to take some time to address this question and set some expectations for what may occur in the second half of 2014.
First, a caveat
I am no better at forecasting the direction of the market than anyone else; not just ‘regular guys on the street,’ but, professionals also. Whether one manages money or is a member of the media writing about money, there is not one person who knows the direction things are headed, nor when that direction turns. A few people standout as having gotten a pivotal event correct, but they are not the same ones who got the pivotal event before or after their ‘big one’ correct. There are just too many factors in play to state a date, a price, and a level of change and the duration of a market rise or drop. So my message here is, ‘don’t even try.’
One part of allocating investments
Instead, we employ a segmented (or bucket) approach to managing your money. Placing your money in figurative buckets eliminates any direct correlation between market volatility and the timing of when you need money for a goal.
As you’ve heard me state before, if you need money in the next one to two years, it should be in cash; if you need money in the next three to five years, it should be in fixed income; and if you need money longer than five years out, it can be invested in equities. The context of each person’s individual situation will adjust these periods within a range. But directionally, this method will allow you and your money a level of security. Let’s examine why.
Stocks since March 2009
March 2009 was the bottom of the last bear market for the S&P 500 index1. A bear market is a prolonged period in which investment prices fall, usually by 20% or more, accompanied by widespread pessimism. During that bear market, the index lost 55.3% of its value over 17 months. Since that time, the S&P 500 has gained 181.6% (as of July 10, 2014) over 64 months.
The nine bear markets prior to 2007 – 09 had an average decline of -32.4% over an average period of 384 days. This means the last one dropped further and faster than average. This is our recent memory.
The battle for investors is to fight against their reflexive nature to sell out and run. This has been a monumental challenge for investors for generations. History shows us several reasons why this is a great mistake for long term investors.
The following exhibit displays the duration, total decline, and subsequent five year return of the most significant S&P 500 Index declines since 1970.
Other than the two month bear in 1998, whose tail end five year return was impacted by the dot-com bubble, and the period from 1968 – 1970, the recovery of the market is undeniable. Though I could have used other period lengths, the five year number provides a level of confidence coinciding with the segmented, or bucket approach to allocating monies.
I have additional data that demonstrates the Year 1 and Year 2 market recovery immediately following the bear market. What you would see is that if you pull out of the market…you’ve missed it. It is in the first 24 months where most of the recovery occurs (Year 1 average of 36% and Year 2 average of 12%). As a result, your best laid plans for long term investing have been quashed by short term actions.
This is the example of the quote I’ve made in several writings, “Don’t let unavoidable events become unrecoverable ones.”
Furthermore, if you had an allocation to cash and fixed income in your portfolio, you had a level of stability which protected you from matching the market drop. And as you know, small company stocks, foreign stocks, real estate and other equities have at times, but not always, allowed for not having your money all move in the same direction.
In other words, when investors hear on the news the level of decline in a day or week, they quickly do the math on their investments to compute a loss. This is not usually the case. If 30% of your portfolio is not invested in the stock market…well, you understand.
So, what is it that I am saying?
Yes, the market will pull back in the future. 64 months of a market rise is a long time. Any rational look at the market would suggest a pullback will occur. Nothing goes up forever.
Yes, the market will be more volatile at some point in time. On average we have had a 14.4% decline in the market each year2. We have not met the average in over 2½ years. Even if we don’t have a bear market, we are going to have to find our way to the average again, and to do that we will be more volatile than the average at some point in time. No, I do not know when or how far the market may fall. When I say, “I don’t know,” I am saying no one knows. Those who say they do, I suggest we check their history of prognostication.
Yes, I am okay with this approaching market decline, because I know that a market decline can act as an opportunity for stocks to be cheaper to purchase. The money managers we employ count on these declines so they do not overpay to own a company.
No, we should not sell your equities. You have cash and fixed income to cover your objectives in the next several years. If your personal needs change, we should address a change based on those. Furthermore, you would have great difficulty picking the exact right time to get back in, hence, missing on the initial recovery discussed above.
And yes, I will continue to view your entire financial picture as primary. You will have money in cash, fixed income, as well as equities, in order to meet your short, mid and long term goals. I will give consideration, that is strong consideration, to the monies you have in equities, and how it will help you achieve adequate long term growth to maintain your standard of living over multiple decades, not just in the next six months.
Finally, I am not suggesting a bear market is imminent this year. Bear markets usually occur when the economy is in recession and unemployment is high, or when inflation is rising quickly.
I look forward to our discussions in the second half of 2014 and thank you for your trust and confidence.
Securities offered through Allegheny Investments, LTD, a registered broker/dealer. Member FINRA/SIPC.
The above comments are provided for discussion purposes only and are not meant to be an offer of any specific investment.