February’s Stock Market Volatility Explained in Four-Letter Words

February’s Stock Market Volatility Explained in Four-Letter Words

 

If you are one of our readers that tunes in more for the planning-oriented articles, you can skip right over this one. Continue with your happy-go-lucky, big-picture perspective.

 

If, however, you want our perspective on recent market events, keep reading.

 

Four-Letter Words

Two four-letter words have recently been coming to my mind: math and fear. (What did you think I was going to say?) One is lacking and the other is overbearing.

 

Several times over recent days I’ve seen the lead story on the nightly news or a title on news articles to be something to the effect of “Market has largest loss on record!” A story like this plays on fear.

 

“News programming uses a hierarchy of if it bleeds, it leads. Fear-based news programming has two aims. The first is to grab the viewer’s attention. In the news media, this is called the teaser. The second aim is to persuade the viewer that the solution for reducing the identified fear will be in the news story.” (Psychology Today, June 2011)

 

The U.S. stock market has recently reached new highs. Then it had large “point” losses. Who cares about points? I don’t nor should you. The Dow fell by more than 1,000 points on two different days the week of February 5th. This amounted to about a 4% decline per day.

 

Black Monday in 1987 only fell by 508 points. Yet, the Dow lost more than 22% that day. You tell me what matters more.

 

I recently read a newspaper article with a fear-based title on college inflation costs. The author stated, “Costs have increased more than 50% over the prior decade!” Yes, the author used an exclamation point. I grabbed my phone and calculated the annual inflation rate, given the author’s 50% stated cumulative increase over ten years. The result: about 4% per year increase, which sounds a little less sensational.

 

When I see writing and reporting done like this, another four-letter word has come to mind … fool. Don’t let the fools fool you.

 

Market Declines

Throughout 2017, we gave clients a quiz prior to our annual progress meeting. These were the two multiple choice questions posed:

 

  1. How often does a 10% U.S. stock market decline happen on average?
    1. Once a year
    2. Every 4 years
    3. Every 10 years
    4. Every 20 years
  2. How often does a 20% U.S. stock market decline happen on average?
    1. Once a year
    2. Every 4 years
    3. Every 10 years
    4. Every 20 years
The correct answers were (1) once a year and (2) every four years. (Source: Capital Research and Management Company for U.S. stock market from 1900-2016.)

 

These questions were asked to more than 120 clients – many of which are not only smart but also well-educated on investing. Probability would say that blind guessing would yield about 8 people getting both right. However, only five answered both correctly. (There were two more that answered both right. However, their faces appeared to be hiding something. When pressed, they admitted they used their phones and Google to find the answer before we entered the meeting room.)

 

Why such dismal results? Investors generally believe the market is not as volatile as it is, and the market had been quite calm for some time. This is exactly why we posed the questions. We wanted to not only remind our clients but prepare them for what inevitably would happen. This is part of investing. Our hope in doing so was to have prudent behavior and discipline when required like now.

 

Until February 2018, we hadn’t had a 10% decline since August 2015. Though we came close to a 20% decline in August of 2011, the last one was in March of 2009 – near the bottom of the Great Recession. So, yes, you can say we were overdue.

 

The average length of these declines has been about 4 months for a 10% decline from market high to market low and 11 months for a 20% decline. The February decline took less than two weeks, but we had outsized gains in January and in 2017.  A diversified portfolio whether conservative or aggressive should only be down a couple percent in 2018.

 

What Should Investors Do

The simple answer is not much. Certainly we will be looking for rebalancing opportunities through this volatility.

 

Some may suggest trying to sit out this volatility. Having a tactical or market-timing approach sounds great. Who wouldn’t want to only participate in the market’s ups but miss the downs. Unfortunately, actual results of investment professionals show timing doesn’t work. Sure some may get lucky a time or two, but luck isn’t a sound principle to base your investment strategy upon.

 

Rather, asset allocation policy explains slightly more than 100 percent of the levels of returns. Why more than 100%? Because market timing and security selection (aka stock picking) subtract returns on average.

 

There’s no way to know if the declines will continue, to what extent they may go, and when the rebound will occur. Thus, stay disciplined and tune out the unintelligent fear-mongering that is very light on relevant math.

 

The market has had stretched valuations for some time. Yet, global economic growth still looks strong.

 

What about higher interest rates? No new news there, but they’re still very low.

 

As a client, you already have a financial life plan that is custom tailored to align your financial resources to meet your goals. Your plan has been stress-tested to ensure you are not taking more investment risk than you can afford. Time to continue to work the plan.

 

Kevin Kroskey, CFP®, MBA
PS – Don’t yet have a sound financial plan and your investments aligned to it? Contact us for a free consultation to learn how we can help you.