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Taking Stock of the Markets

| November 21, 2018
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“U.S. Stocks Hit Hard as Tech Worries Deepen” read the front-page headline in today’s Wall Street Journal. The article’s opening sentence succinctly summarized the rest of the article that followed: “U.S. stocks lurched lower Monday, deepening an autumn slump that has shaken many investors’ confidence in the technology titans that had led the bull market higher for much of the past year.” The chart below shows that through the first seven-plus weeks of the fourth quarter, as of the market close on November 19, U.S. (S&P 500 Index), international developed markets (MSCI World ex. USA Index) and emerging markets stocks (MSCI Emerging Markets Index) were all down more than 5% since the end of the third quarter, according the index data from Ycharts.[1]

 

As a result of each of these markets’ recent slide all three indexes are trading at levels noticeably below their respective all-time highs. For instance, the chart below reveals that the S&P 500 Index is now nearly 8% off of its all-time high which it achieved during the last week of the third quarter. International developed and emerging market indexes are even further from their all-time highs which were last achieved earlier this year in January. This chart also reveals how international and emerging market stocks really didn’t take part in the market gains that occurred during the middle part of the year in U.S. stocks, which is a topic we’ve written about on multiple other occasions.

 

With U.S. stocks now within shouting distance of the relatively meaningless, yet psychologically significant 10% decline threshold that’s commonly used to define a market “correction,” we thought you may appreciate knowing what’s happened historically following a 10% drawdown. While we will be the first to admit that we do not know where stocks will go from here (and we’ll also note that no one else does either), we do believe that a firm understanding of market history is nevertheless informative and useful for helping us and our clients to form rational expectations and to define a potential range of outcomes that may occur.

The data below comes from a fellow evidence-based investor, Ben Carlson, who examined what’s historically happened to the S&P 500 Index after it declined by 10%.[2] Ben examined the 47 separate instances where the S&P 500 declined by 10% or more and documented how far the index ultimately declined from its all-time high prior to bottoming out. The table below presents the results of Ben’s analysis.

 The table shows that:

  • Nearly half of the time (45%), historically, the index fell less than 15% in all from the high (i.e., another 5% after breeching the 10% decline threshold)
  • Nearly 60% of the time (57%), the drawdown did not ultimately reach “bear market” territory, using the standard 20% decline threshold
  • Approximately three-quarters of the time (74%), the market declined less than 30%

The conclusion to Ben’s commentary was fantastic. Rather than attempt to improve upon it, we copy his concluding paragraphs below.

Historical information like this can help put things into perspective but historical data is rarely enough to help people sleep at night or change their behavior. Market averages tell a story but no one’s experience in the markets is ever average in the moment.

The past is easy because we know what happened but the future is messy since the uncertainty of the potential outcomes cannot be reduced.

Most of the time the stock market has a run-of-the-mill correction that doesn’t turn into a bear market but a bear market is always a possibility. And every time stocks begin to fall there’s a little voice in the back of our heads that tell us, “Maybe this is the big one…”

Intelligent investors bake these scenarios into their investment plan and prepare for them in advance. No matter the path stocks take from here, if you don’t have a plan in place about how to react no matter the outcome, now would be a good time to formulate one.

Even a bad plan is better than no plan at all.

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Two additional observations on the current market environment:

#1 Value stocks have fared far better than growth stocks.

The recent market pullback has also coincided with a sharp divergence in the performance of value stocks and growth stocks in the U.S. The chart presented below demonstrates that fourth quarter downturn in U.S. value stocks (Russell 1000 Value Index) has paled in comparison to that of U.S. growth stocks (Russell 1000 Growth Index).

Regular readers will likely recall that this marks a sharp reversal of the trend that took place during the first nine months of the year whereby growth stocks dramatically outperformed their value peers. The chart below shows how the recent relative outperformance of value stocks has served to considerably narrow the year-to-date performance gap that had developed between the two market segments during the first three quarter of the year.

 

#2 Bonds have largely fulfilled their role during the current stock market pullback.

We believe that the primary role of high-quality, investment-grade bonds in a diversified investor’s portfolio is to diversify equity market risk and to provide ballast to the portfolio. This recent episode of declining markets and heightened volatility has once again clearly demonstrated the valuable role bonds can play in a portfolio—even in an environment like today of generally rising interest rates. The chart below demonstrates that despite generally rising interest rates, investment grade taxable and municipal bonds have held up quite well during the recent market swoon.

We hope this was found to be both informative and helpful.  If you'd like to talk about your financial situation, please reach out to schedule a call or meeting. 

[1] All data unless otherwise noted is from Ycharts.

[2]“When Stocks Fell 10%...” by Ben Carlson; October 25, 2018.

 

 

IMPORTANT DISCLOSURES

 

Past performance is no guarantee of future results.

Indices are not available for direct investment. Their performance does not reflect the expenses associated with the management of an actual portfolio.

All performance referenced is historical and is no guarantee of future results.

No strategy assures success or protects against loss.

There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.

The opinions voiced in this material are for general information only and are not intended to provide or be construed as providing specific investment advice or recommendations for any individual security. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing.

The economic forecasts set forth in this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful.

All investing involves risk including loss of principal.

Investing in stock includes numerous specific risks including: the fluctuation of dividend, loss of principal, and potential liquidity of the investment in a falling market.

Investing in foreign and emerging markets securities involves special additional risks. These risks include, but are not limited to, currency risk, geopolitical risk, and risk associated with varying accounting standards. Investing in emerging markets may accentuate these risks.

Value investments can perform differently from the market a whole. They can remain undervalued for long periods of time.

Bond are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise and bonds are subject to availability and change in price.

 

 

INDEX DESCRIPTIONS

Standard & Poor’s 500 Index is a capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.

Bloomberg Barclays US Aggregate Index is a broad-based benchmark that measures the investment-grade, U.S. dollar-denominated, fixed-rate taxable bond market. The index includes Treasuries, government-related and corporate securities, MBS (agency fixed-rate and hybrid ARM pass-throughs), ABS, and CMBS (agency and non-agency).

Bloomberg Barclays Municipal Index covers the USD-denominated long-term tax-exempt bond market. The index has four main sectors: state and local general obligation bonds, revenue bonds, insured bonds, and pre-refunded bonds.

MSCI World ex USA Index is a free float‐adjusted market capitalization weighted index that is designed to measure the equity market performance of 22 of the 23 developed markets included the MSCI World Index (excluding the US).

MSCI Emerging Markets Index is a free float-adjusted market capitalization weighted index that is designed to measure the equity market performance of the emerging market countries of the Americas, Europe, the Middle East, Africa and Asia.

Russell 1000 Value Index measures the performance of the broad value segment of U.S. equity value universe. It includes those Russell 1000 companies with lower price-to-book ratios and lower forecasted growth values.

Russell 1000 Growth Index measures the performance of the broad value segment of U.S. equity value universe. It includes those Russell 1000 companies with high price-to-book ratios and hgih forecasted growth values.

 

Securities offered through LPL Financial, Member FINRA/SIPC. Investment advice offered through Private Advisor Group, a Registered Investment Advisor. Private Advisor Group and Kathmere Capital Management are separate entities from LPL Financial.

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