Do You Have a “Stomach of Steel” in this Stock Market Environment?

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The Wall Street Journal Called

Rick Kahler MS CFP

By Rick Kahler CFP® CLU MS http://www.KahlerFinancial.com

[FOMC Holds Steady Today]

A few weeks ago, when the US markets started dropping dramatically, a reporter for The Wall Street Journal called. He asked me if I had received any calls from worried clients. I told him I had heard from 5% of my clients. “What changes in their portfolios are you making?” he asked.

“I’m not making any changes to my investment strategy.”

He expressed amazement that I was not “doing something.” Most investors and their advisors he was speaking with were making “adjustments” to their portfolios. He told me I must have a “stomach of steel.”

Hardly. My gut is certainly not immune to those fearful sinking feelings that go along with market plunges. What I do have is enough experience to trust my long-term investment strategy.

The time most investors and advisors decide an investment strategy doesn’t work is when their portfolios lose value, usually due to a decline in US stocks. This confuses me.

Here’s why:

First, I’m confused that so many investors believe it’s possible to move in and out of markets in such a way that their portfolios will rarely, if ever, suffer a negative return.

This is magical or delusional thinking. The only investor I’m aware of who consistently produced positive returns, year after year, was a fellow by the name of Bernie Madoff. If you have never heard of this investment wizard, he’s the one who is now serving a life sentence in a federal prison for propagating a Ponzi scheme that robbed billions of dollars from investors.

Short-term or moderate-term losses are inevitable in any portfolio that seeks to earn returns above those offered by a bank Certificate of Deposit. Usually, in the long run, markets recover and so does your portfolio.

Sadly, too many investors turn short-term losses into long-term losses by abandoning their investment strategy when the US markets turn down. This locks in their losses, never to be recovered.

If your portfolio is widely diversified among many markets—like bonds, emerging markets, commodities, real estate, TIPs, and various investment strategies—you will almost always have an asset class losing money. You will also almost always have an asset class making money. If not, you probably don’t have a diversified portfolio.

Here’s the second reason I’m confused.

Most investment strategies assume that the US market will decline, and they have a strategy in place for dealing with those declines. For a buy-and-hold investor, the strategy is to do absolutely nothing. For a strategic asset allocator like myself, it’s to rebalance frequently by selling appreciating asset classes and buying into those in decline. By not making changes to clients’ portfolios during a market decline, I am not “doing nothing;” I am simply continuing to follow an investment strategy.

Because most of my clients have learned over time to trust this strategy, relatively few of them make panicky calls to my office during downturns. Yet I have noticed a direct correlation between US stock market declines and my daily phone call volume. Many of the calls are from reporters wanting to know what I am doing and am telling clients. My response—that I’m not doing anything different—is the same thing I told them when the markets last declined in 2011 and before that in 2009, 2008, 2002, 2001, 2000, 1997, etc.

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Assessment

This isn’t the response an anxious client or a concerned reporter wants to hear. When the emotional center of the brain is overcome with panic and fear, taking action helps relieve anxiety. If that short-term action is selling into volatile stock markets, however, it often turns out to be a long-term mistake.

Conclusion

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2 Responses

  1. Some perspective on yesterday’s market volatility

    Equity markets slid into the weekend as investors adjusted their portfolios to reflect revised views on near-term Federal Reserve policy. A shift of investment capital out of stocks and back into bonds seemed to be the primary driver of today’s action as investors re-evaluated their expectations regarding the potential timing of Federal Reserve interest rates hikes.

    What it all means

    Yesterday’s Federal Reserve decision suggested officials are likely taking a more dovish view of economic conditions than market participants previously perceived. Bond prices fall as interest rates rise, so the perception that interest rates are likely to remain lower for longer made bonds look relatively more attractive. In other words, with near-term interest rate hikes now less likely, it was safe for bond investors to “go back into the water.”

    This action was likely reflective of this re-allocation of funds from one asset class to another (out of stocks, into bonds). What little economic data there was for investors to consider was generally positive.

    Notably, Spain reported much stronger than expected new industrial orders (up a strong 8.9% yr/yr). Today was also a “quadruple witching” day on Wall Street whereby there is the simultaneous expiration of stock index futures, stock-options, stock-index options and individual stock futures. There are four such days a year and they typically see heightened volatility.

    All ten sectors of the S&P 500 were lower with financial sector issues amongst the biggest losers. The sector had been perceived as benefiting from rising interest rates as higher rates are typically good for bank profitability.

    As noted, bonds did well. The yield on the 10-year Treasury fell to 2.13% as compared to a level of 2.3% on Wednesday – the day before the Fed announcement. Today’s closing yield for the 10-year matches its lowest level since the heart of the recent correction (August 25th).

    Overall, we believe today’s sell-off was likely reflective of a temporary re-adjustment of portfolios rather than a re-emergence of global growth concerns. The Federal Reserve noted concerns regarding global growth in their decision to maintain their interest rate targets, but we did not see the Fed’s assessment of conditions as new information.

    Russell T. Price CFA
    via Daniel J. Antokal MBA
    [Financial Advisor]

    Like

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