|
Investment Planning |
Today's stock market: stay the course
We are obviously in a period of market decline, but how does your portfolio measure up to the overall decline? The purpose of this market commentary is to provide you with perspective about the current stock market decline that started in 2000. The S&P 500, an index comprised of the 500 largest companies in the U.S., is a good proxy for the performance of the U.S. stock market. The S&P 500 reached an all-time high of 1527 on March 24, 2000. The S&P 500 closed at 1116 on September 6, 2001. That's a decline of 27%. Prior to the current decline, the most recent major decline was the 1987 market crash, which had a peak to trough decline of 33.5%. And after that, between December 1987 and March 2000, we saw the greatest bull market in history, when the S&P shot up 582%.
Historically, market cycles have acted in a similar fashion: after hitting bottom, they have eventually turned around and continued on to reach new highs. Here are a few important points about market cycles:
-
1. To get back to breakeven and to recover the amount of your losses, the percentage increase from the market bottom has to be greater than the percentage decrease from the market top. Let's look at an example. A stock that is worth $100 declines to $75. That's a 25% drop. To get from $75 back to $100, the stock must rise by 33%.
2. The length of time to get back to breakeven has varied in the past; sometimes the recovery is fast. In the 1987 correction, the S&P 500 peaked at 337 in August 1987 and reached bottom in December 1987. After the 1987 correction, it took 19 months for the market to reach its peak of 337 again, resulting in a 50% return from trough to breakeven. An even shorter market recovery was seen in the early 1980s. After the S&P 500 declined 27% from November 1980 to August 1982, it rose 37% from August to October 1982, recovering from the prior decline in only two months. This is an excellent example of why you should stay fully invested - because market recoveries can be swift.
3. Risk is inherent in stock market investing. Over the long term investors expect a higher return for investing in the stock market because they must stomach the ups and downs of the value of their investment. Sometimes the recovery from market bottom to breakeven takes a long time. The S&P 500 declined 48% from 120 in January 1973 to 62 in October 1974. It took almost six years, until July 1980, to get back to 120.
Diversification and patience are the pillars of our investment strategy. Not surprisingly, your diversified asset allocation has mitigated the negative consequences of the stock market's 17-month decline. During these turbulent months, the S&P 500 has declined 26% and the Nasdaq has plunged 64%. We currently use eight distinct asset classes for our clients' diversified portfolios. The purpose of asset allocation is to combine asset classes that behave differently in such amounts as to maximize the expected return of a portfolio for a given level of risk; to say it differently, we attempt to maximize your risk-adjusted rate of return. In the past, the market has fared very well after a 25% decline if investors waited at least one year. There have been four S&P 500 declines of at least 25% in the past 40 years and in each case stocks were higher by at least 16% one year later.
Stay fully invested during the market downturn, with the goal of preserving your overall wealth. Rational, unemotional investors are the ones who will profit when the market turns around; being fully invested they need not worry about timing a market uptick. As long as you do not need the assets in your long-term diversified portfolio for at least five years, there is no reason to panic during this market decline. History has shown that stocks are a safe investment if your time horizon is at least five years. Since 1950, there have been only two five-year holding periods out of 51 years when large U.S. stocks had negative returns: 1970 to1974 and 1973 to 1977. Down markets have eventually turned around, and following such a turnaround, the markets have risen to record levels after every downturn.
What should you do now?
Be conscious of the current market and your short-and long-term goals. If you have new money to invest, consider dollar-cost averaging. If there is a much larger decline in stocks from here forward that would create huge bargains and set us up for a big bull market rebound. For long-term investors this is the most attractive scenario because it offers an opportunity to buy more stocks at bargain prices.
Tips Disclaimer
These tips contain information that may change over time as a result of new tax legislation. Although we make efforts to keep this information current, you should check with your tax advisor before taking action based upon any information contained in these tips.