In light of recent volatility in global markets and the steep sell-off of over the past week, we want to share a few comments that we hope will prove helpful in shaping your own views.
1. A little perspective is always valuable
It is worth noting that although the US hasn’t seen a stock market decline of this magnitude in quite some time, market corrections are a normal and healthy part of market movement. While our market regime indicators (as well as those of most of our investment strategists) are elevated, they have not yet been triggered indicating this correction to be the next 2008. For this reason, we are reluctant to characterize today as either a buying or a selling opportunity. Instead we believe the next few days, or maybe weeks, will tell us whether the future of market prices will be driven by fundamental values or by fear.
2. In general, investors should not sell when a correction seems based on fundamentals
Historically, this type of decline has been limited in depth. In addition, fundamental corrections have tended to recover more quickly than the fear-driven market dislocations that take place when valuations become irrelevant and investor behavior is driven by anxiety. At this time, markets have not become “irrational” in their pricing. While US stocks were down almost 4% for the day on Monday, the decline was much worse at the open before buyers who saw attractive valuations stepped in and brought the market well above its morning lows.
3. Fundamentals still look promising for US and European economies
While the challenges faced by China and emerging markets more broadly will slow growth in developed markets, there is little reason to believe these challenges will result in a global recession. The US and European economies still appear poised for growth, albeit slow growth.
4. They won’t ring a bell at the top: In reviewing the persistent market concerns, it’s important to remember that while they are worrisome, they are not a reason to panic and move to 100% cash. Over the course of our 30-year history, we’ve never tried to time market tops and we don’t have to. That’s because bull market peaks are usually slow, rounding affairs that take time to develop and are accompanied by increasing bearish warning flags. Unlike V-shaped market bottoms, tops give us a longer period to assess the weight of evidence and adjust the portfolio accordingly. Even in the “crash” of 2008, investors had at least nine months surrounding the peak to step up defenses.
5. The Fed may clarify its position on interest rates, boosting investor confidence
Beyond China, another factor in domestic investor anxiety is uncertainty about a Fed interest rate increase in September and what impact higher rates might have on the stock market. Last week's sharp sell-off in the US and global equity markets may encourage the Fed to delay raising interest rates until December or March, since the rate hike is not necessitated by inflation but rather a desire by the Fed to reload some monetary ammunition to stimulate the economy in the event of an economic slowdown. An indication from the Fed that it will delay raising rates might motivate buyers on the sideline. Conversely, even if rates rise, the certainty of the Fed’s move will provide investors greater confidence than the anxiety caused by the unknown.
6. Market volatility helps show the value of a managed, diversified portfolio of investment styles
The past week only strengthens our conviction that diversified portfolios have higher likelihood of helping you stay on track. History has shown us that the opportunity cost of sitting in cash for long periods (waiting for the "all clear") far outweighs the losses associated with staying invested through a full market downturn. It is for this reason that we generally like to recommend a portion of most portfolios be allocated to tactical strategies with a discipline for when to reduce and when to add back equity market exposure.
At the hallmark of our investing process at FMN is the concept of diversification, both in what you own and in the strategy that is used to manage risk. We’ll continue to use some of the most widely used methods of risk management; diversification, asset allocation, hedging, and the use of uncorrelated assets (investments that don’t move in lock step with the market). If this correction proves to be similar to those seen in 2011 and 2012, we’ll certainly be looking to purchase at that time. This is the only way to “buy low and sell high”, at some point you have to rebalance and actually purchase on these dips when the opportunity presents itself. We’re not there yet, but we may be soon.