Market Corrections and Winter Diets

For some time now, we have heard that the market is getting a little “puffy.” Times have been good, and many have worried that market prices may have gotten a little ahead of intrinsic values. It is interesting that I have been observing the same phenomenon in the mirror as the holiday snacking has led to the addition of a few winter pounds. Perhaps it is time for a little post-holiday diet, and basically we believe that is what is now occurring in the market.

We have not had any significant market volatility in almost two years. Market volatility refers to the see-saw effect we have been experiencing this week. Upward momentum is pleasant, although it can be worrisome if it is too constant, but downward movement is almost always unpleasant. No one likes the sensation of losing money; but should that be alarming? During times of market downturns, it is important to take a step back and ask, “What is the job of my investment portfolio?” If it is a retirement portfolio that is not expected to generate cash flow for living expenses for ten or more years, it makes sense to have investments in volatile growth assets like stocks. Why? Because despite occasional pullbacks like this one and worse, stocks have a strong history of returning higher average total returns over time than more stable assets like cash and bonds. In short, since you will not be drawing on the portfolio for ten years, you can withstand a few dispiriting quarterly reports in exchange for the opportunity of long term portfolio growth. On the other hand, if the job of the portfolio is to provide cash to buy a new vehicle next month, and the portfolio is heavily weighted toward volatile growth investments, then a 10% drop in value might have a very real impact on the type of vehicle you buy. In this instance, your sense of losing something is visceral and real.

This is why we always ask clients to keep us well informed of their cash flow needs. This is also why all client portfolios do not necessarily look alike, because client goals differ. For many, even those in retirement, a portfolio thoughtfully balanced between growth and more stable investments will provide the dividends and interest needed to cover most of the cash flow that clients need while their portfolios weather the occasional market squalls that seemingly come out of the blue.

In fact, this squall seemed to originate from what would appear to be good news! The U.S. economy appears to be strong and resilient. Unemployment is down and wages are finally slightly up after years of nearly flat wage growth. The worry is if the labor market is getting tight and wages are up, then this might put pressure on corporate earnings, negatively affecting stock values. Tight labor and increased wages might also cause increased inflation expectations after a long period of very low inflation. This, in turn, could prompt central banks and lenders to increase interest rates to throw a sea anchor out to cool down the economy. Rising interest rates will increase the cost of corporate debt, putting pressure on corporate earnings, hence stock prices pull back on lowered earnings expectations.

There have been plenty of times over the past few years when we thought a market pullback might occur. While we might be able to suggest why it is occurring, the timing is frustratingly random and impossible to predict. Attempting to time the market has historically produced dismal results. This is why we try to design all-weather portfolios that reflect each client’s time horizon and risk tolerance.

While market pullbacks are never fun, we do not think the current downdraft is cause for great alarm. Certainly we have political challenges, but setting those issues aside, the global economy is showing signs of healing after the damage done by the great recession almost ten years ago. That recession occurred because we had serious structural economic problems that led to an implosion that took years to heal. We believe the current market pullback, while unsettling, is a relatively normal occurrence rather than a repeat of the cataclysmic event of 2008.

Earlier this week we posted to our Deighan.com blog two excellent articles written by a colleague who shares our view of this market. We have removed them from our blog because our colleague has asked all advisors to remove the articles from blogs and to instead email or send the articles directly to clients. Thus, we have resent the articles directly to clients via email, placing this summary for all on our blog instead. We are delighted to discuss the current market or other financial issues with any interested party. Meanwhile, we will try to resist what’s left of the delicious holiday chocolates in our attempt to follow the market into less puffy territory, and will seek opportunities to load our plates with leaner offerings that will eventually lead to better overall health.

The Deighan Team