We are experiencing our first broad-based drop in stock markets for many years. Just last week, the drop in the S&P 500 from its September high surpassed 10%. Moreover, US large company stocks are actually one of the better performing stock asset classes, with declines in foreign stocks and smaller company stocks nearing or even exceeding 20% now. Following on the heels of a calm 2017 (when the S&P 500 rose each and every month), this downturn feels like a genuine shock.
Why is Downside Volatility Resurfacing Now?
We can point to many reasons why downside volatility is resurfacing now. The Federal Reserve has been raising rates for nearly 3 years now and short-term rates, especially, look relatively more attractive. The slim difference between short and long-term interest rates (the spread between 2- and 10-year US Treasuries has narrowed to nearly nothing) is seen by many as a signal of looming recession. Costly trade disputes with our largest trade partners are a drag on global business activity. The messy Brexit process underway in the United Kingdom is another source of uncertainty. Lastly, we recognize that the US is in the later stages of the economic cycle (GDP has expanded continuously for nearly a decade).
Truth be told, though, each of the important and relevant factors cited above was apparent well before the last few months and didn’t prevent the US stock market from rising through most of the year. There is simply no way to predict or time market turns. Absent that, here are a few thoughts to help manage through this downturn and stick with your long-term plan.
How to Better Manage a Downturn
First, it’s helpful to recall that this type of downturn really shouldn’t come as a shock. Even though we never know when or why they will happen, corrections and bear markets are a regular feature of the stock market. They are part of the long-term bargain offered by equity investing: near-term volatility and downside risk in exchange for higher expected long-term returns. The two charts below attempt to illustrate that tradeoff. First is a chart showing the magnitude of drops in the S&P 500 from its high over the last 10 years (when the line is at zero, the S&P 500 was at or near a record high, drops into negative numbers show the magnitude of declines from that high).
The following chart, meanwhile, shows the cumulative percentage return of the S&P 500 over the exact same period, which puts the recent pullback in some context.
It’s also useful to remember, especially during times of market stress, that your investments are not pieces of paper or tickers scrolling across a screen. In this age of 24-hour financial news, indexing, ETFs and all the other complexities of the current investing landscape, there is an ever-greater disconnect with what you own in your portfolio. So it is helpful to remember that we invest on your behalf in pieces of real businesses (in the case of stocks) or obligations of companies and governments (in the case of bonds).
For example, at Bristlecone Value Partners we've recently been adding shares of the global brewer Anheuser-Busch to the large cap value portfolio. Anheuser-Busch is a company that has been around for more than a century and there is every reason to believe it will be around for the next century. It will have its ups and downs, but we also believe it very likely will continue selling more beer around the world and growing in value over the next decade, regardless of what happens to its stock price in the next few months.
Diversification to Withstand Downturns
For the most part, the above discussion pertains to stocks, but nearly all of you have balanced portfolios comprised of stocks and bonds. In constructing your investment plan, we’ve attempted to address your intermediate-term income needs (for the next 3 – 5 years) by having a portion of your portfolio in high quality bonds that are fairly stable in value. This diversification should allow your portfolio to withstand downturns such as this (or even worse) without disrupting your income needs or longer-term investments. That should provide peace of mind to stick to your long-term plan.
We don’t know how low prices will go or when the decline will reverse—nobody does. We won’t attempt to time the market. We will rebalance your portfolio and try to be opportunistic if good values appear. If you have the possibility of adding to your portfolio when the market is down (or just withdrawing less), that can pay long-term dividends.
All of us at Bristlecone wish you a wonderful holiday season and a Happy New Year.
Feeling Stressed by These Market Conditions?
It's natural. Please don’t hesitate to reach out to us to ask questions or discuss your portfolio; we’re here to help.