Fourth Quarter 2018 Was So Much Fun

January 17, 2019 8:00 am

What did Fourth Quarter 2018 tell us about the future? Not much more than the rest of 2018 did. But in case you missed it, stocks around the globe experienced a significant decline during the quarter, a trend that began in October and accelerated rapidly in December. The downturn was widely attributed to the prospect of continued higher interest rates, ongoing tensions in the trade war between the U.S. and China, and earnings pressure on technology giants such as Facebook and Apple.

The December sell-off was steep and significant, with the Dow dropping more than 12% and the Russell 2000 small stock index dropping almost 14% in just nine trading sessions from December 12 – 24. Other than the one-day “Flash Crash” of 2010, it was the most significant bout of volatility for stocks since the 2008-09 financial crisis. The decline brought the Dow Jones Industrial Average within a fraction of a percent of a bear market (defined as a 20% decline from peak to trough).

While the percentage declines were significant, they have been nowhere near the declines seen in 2008-09. The breadth of the declines across so many asset classes, however, was historically significant. According to a Deutsche Bank / Bloomberg Finance report, some 93% of all global asset classes experienced a negative total return in 2018. That was the highest percentage of asset classes to experience a decline going all the way back to 1901.

Percentage of Global Assets With Negative Total Returns

When a downturn hits the stock market that is both deep and wide, the news media, predictably, goes into full crisis mode. Stories appear almost continually on our TVs and financial news web sites, chronicling the downturn in real time and warning about the possibility that the decline may yet get worse. In such times of turmoil, it becomes challenging for long-term investors to avoid the temptation to make short-term moves with their investments.

Have you ever bought that fancy health food magazine off the rack in January after you indulged too much over the holidays? Yes, I know most of us have (which I’ll discuss why below).

It is precisely at these inflection points in the market that long-term investors must avoid that temptation. History has shown us, repeatedly, that making rash decisions with our investments during periods of extreme volatility is almost always the wrong thing to do, because it creates two critical decisions that must be correctly made: when to get out of the market, and when to get back in. Making a wrong move on either or both of these decisions can result in a tremendous loss of investment capital. As many of you have heard me say, sometimes it is not about being smarter than everyone else, but instead doing a lot less stupid things that allows you to have a successful investing experience.

WHO SHOULD WORRY

No matter how disciplined one is, it’s not easy to watch such large market movements as we saw in December. The only people who might have a reason for concern when this happens are:

Retirees taking income from their portfolio

Investors with NO financial plan in place

For investors who are well-diversified, have a sound retirement income strategy and wealth management plan in place, perspective is the most important quality to maintain during times of market turmoil. In that regard, here are three points to keep in mind in the current market environment:

We were due for a bear market: Actually, by historical standards, we were overdue. On average, the stock market experiences a correction (a decline of 10%) about once a year, and a full-fledged bear market about every 3.5 years. Prior to the current downturn, the last 20% decline in the S&P 500 occurred in 2008-09. From that perspective, a bear market shouldn’t come as a surprise.

The thing about past bear markets, of course, is that we know how they turned out. We don’t fear the 1973-74 bear market, when the Dow dropped 45% and bottomed out at 577, because it’s ancient history; a once-scary story that we now know has a happy ending. Even the 2008-09 bear market doesn’t generate the same anxiety today, with the Dow about 20,000, as it did in real time, when the Dow bottomed out at 6,443.

In real time, though, we don’t know where the market bottom is, and that’s where the anxiety lies. Fear of the unknown often causes investors to make panicky, emotion-driven decisions in an effort to “protect” their assets by reducing or even eliminating their stock exposure usually after the market has already made a substantial move downward.

The thing about moving to the perceived safety of less volatile investments like bonds and cash during a downturn is that, once the dust clears and the market turns up again, it usually turns up in a big way. Much of the recovery happens before most investors realize it, and big gains that were there for the taking by those who are fully invested are missed by those sitting on the sidelines.

The recovery from the bottom of the 2008-09 bear market is a vivid example. Once the bottom was reached on March 9, 2009, stocks took off rapidly and unexpectedly. By June 30, 2009, the Dow had gained 29.47% from the bear-market low; by year-end 2009, it had gained a whopping 61.98%.

Even the events of the past few weeks have illustrated this tendency of stocks to bounce hard off their lows. After hitting a recent low of 21,792 following a 653-point plunge on Christmas Eve, the Dow, as of this writing, has recovered nearly 2,500 points and nearly 11%. Whether stocks revisit their lows again in the short term, go lower still or start rising and never look back – no one knows. What we do know is that, once the volatility settles down and the market is in calmer seas, stocks typically spring back in dramatic fashion.

In turbulent markets, focus on the process, not predictions: No one can control the direction of the stock market, so it makes sense to focus on the things we can control in down markets. For taxable investors, a stock downturn can offer an opportunity for portfolio rebalancing and tax-loss harvesting to help offset taxable income. Focusing on maximizing the efficiency of the wealth management process during turbulent times helps to reduce the anxiety of wondering when the market volatility will end.

Take a break from the news: A half-century ago, investors didn’t have the ability to follow the stock market moment-by-moment. They might hear a mid-day report on the radio, and then get a brief market recap on the nightly news at day’s end. Other than that – out of sight, out of mind.

What a contrast to the world we live in today. Our phones push market information to us constantly, with stock ticker apps, email alerts, and updates on our internet browsers every time we open Chrome, Explorer or Safari. Even if we wanted to, it would require a genuine effort to be unaware of the constant fluctuations of the market – especially when the market is in a downturn. Eyeballs equal money for content providers, and the more dramatic they make the content, the more likely we are to watch or click on it. These TV shows and web sites are populated with a legion of so-called experts pontificating on where the market is heading and what stocks to buy or sell to minimize the “damage” to your portfolio.

SEARCHING FOR EL DORADO

Are you still wondering why we buy that new health magazine each year or seem to try the latest workout craze that is “guaranteed” to be the answer? What if instead these media outlets told you to work out more, eat better, and get more rest? How many magazines would they sell beyond the first issue? You know the answer.

All of it is bunk. If these experts truly knew where to be ahead of time, they wouldn’t need to work for a living. Given that 80% of mutual-fund managers – among the best and brightest minds in the investment industry – routinely underperform the market over 10-year periods, why would we believe that the analyst-du-jour on CNBC has any better grasp of how to beat the market?

The herd mentality becomes strong during periods of extremes in the stock market, both on the upside and the downside. Just as it seemed the smart money was in dot-com stocks in 1999 and Florida real estate in 2006, the opposite mentality sets in during down markets. We hear water-cooler conversations among friends and family about how this downturn just “feels different” than others, or why someone has moved their entire 401(k) allocation to cash until things calm down.

During periods of market turbulence, it’s important to remember that individual investors, as a group, are notoriously out of synch with market reality. The guesses and opinions our friends and neighbors are offering about the market aren’t any different than those offered by the talking heads on TV. It’s all based on hunches and suppositions, and that’s no way to manage your investments. To the contrary, process, discipline and a healthy dose of emotional detachment are the best ways to ride out a downturn in the market.

As always, we appreciate our relationship with you and we are here to help.

Best,
Marc

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Source:  MSCI; Deutsche Bank; Bloomberg; Standard & Poors; Morningstar, Inc. Dimensional Fund Advisors LP. DFA 2018 Mutual Fund Landscape Report. Indices are not available for direct investment. Their performance does not reflect the expenses associated with the management of an actual portfolio. Past performance is not a guarantee of future results. Diversification does not eliminate the risk of market loss.M & A Consulting Group, LLC, doing business as CAM Investor Solutions is an SEC registered investment adviser. We provide financial planning and investment information that we believe to be useful and accurate. However, there cannot be any guarantees. There are many different interpretations of investment statistics and many different ideas about how to best use them. Nothing in this presentation should be interpreted to state or imply that past results are an indication of future performance. Tax planning and investment illustrations are provided for educational purposes and should not be considered tax advice or recommendations. Investors should seek additional advice from their financial advisor or tax professional.

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This post was written by Marc Jimenez, CFA, CFP®

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