Why are stock markets deviating from their almost 9 years of going up? Nearly all economic data are pointing to an accelerated economy, so why is the market not reacting to positive economic news?
For starters, the stock market does not necessarily react to the economy. For almost nine years, beginning with the market low in March 2009 and continuing through January 2018, the S&P 500 index, with dividends reinvested, has gained over 340%. Like the stock market, trees can grow very high, but they cannot touch the sky.
We have all heard that market corrections are heathy. The problem for investors is that we do not feel healthy when we see our 2018 gains wiped out in in a couple of weeks, but market corrections can be very healthy for the financial markets and to our personal investment portfolio.
Think back to the recession from December 2007 to June 2009. During this stock market decline, many stocks went on sale dirt cheap. This can be illustrated by the Price to Earnings Ratio (P/E Ratio), which measures a stock’s share price relative to its per share earnings. This means that the P/E ratio indicates the dollar amount an investor can expect to invest in a company in order to receive one dollar of that company’s earnings.
The P/E is often referred to as the price multiple because it shows how much investors are willing to pay per dollar of earnings. The historical average P/E ratio for the S&P 500 index is about 16 times earnings. Looking back to 2009, the P/E ratio for the S&P 500 index was as high as 70.9 times earnings and dipped to 14.87 in 2012. The P/E ratio for February 2018 is estimated at 25.73 times earnings.
Why is it when markets go on sale people get afraid, but when retailers have sales, like Black Friday, people are spending money in abundance? Today, in general, stocks are trading at very high P/E ratios, and it was inevitable that they needed to correct at some point.
What created the recovery of the last recession was very intentional. Both in the U.S. and abroad, the governments got involved and lowered interest rates to the point where borrowing became almost free. Investors eventually put money back into stocks and real estate.
It took a while, but it worked. Because stock prices had gotten so low, this created an opportunity for a recovery, lasting almost nine years.
The fact that the stock market recently experienced a correction on February 8, 2018 as the DJIA and the S&P 500 fell more than 10% from recent highs in late January (and are more volatile) has little to do with the economy. Even though the economy has good fundamentals, with the Gross National Product expected to be 3% this year, very low unemployment, wage increases, and the possible positive outcome of tax overhaul, no one knows whether this volatility will continue or for how long.
Warren Buffett, an American business magnate, investor, and philanthropist who serves as the chairman and CEO of Berkshire Hathaway, has been noted for telling people to shut off the news, stop reading the internet and newspapers, relax, and to go eat an ice cream cone. For some this may be easier to do than others, but just stay mindful that the media goes into a frenzy during periods of market volatility.
Many of the media represents for-profit institutions that are in business to make money. The bulk of the media’s revenues come from advertising, so they are highly motivated to attract as many viewers and website clicks as possible.
Handling Emotion
Meanwhile, how should you handle your emotions from causing you to make rash investment decisions, which rarely turn out to be the best decisions? Panic selling without considering logic is seldom wise, especially if you are five plus years to retirement.
However, you may want to review your investment holdings to see if the recent bull market has caused your asset allocation to get out of line which may require the need to rebalance your portfolio.
On the other hand, those of you that are nearing retirement should evaluate your risk levels to make sure they match your comfort level, meaning, how much could you comfortably risk and not jeopardize your retirement income goals? This is particularly true if your 2017-year end values are close to what they are now and you are on the path to “winning the game”, meaning you have reached your savings goal to meet your desired income in retirement. It may make sense to shift some of your assets into more conservative and protected vehicles.
Please do not construe this as investment advice, because I am talking in general terms. Everyone has different situations and different needs, along with distinctive views on risk. Now is the time to be visiting with your financial advisor to get professional advice that is specific to you.
Below are a few of my favorite quotes from legendary investors:
“It would be wonderful if we could avoid the common setbacks with timely exits.”
– Peter Lynch
“The four most dangerous words in investing: ‘this time it’s different.’”
– Sir John Templeton
“The most important quality for an investor is temperament, not intellect.”
– Warren Buffett
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