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Turbulent Market Hypothesis

If you’ve checked on the market news more than once in the last couple of months, you may have been a little confused. World stock markets tumbled one day, rallied strongly the next — and normally boring commentators excitedly offered conflicting explanations. Were markets worried that the Federal Reserve would begin raising rates, or that they would not? Was China’s economy slowing significantly, just taking a brief breather, or was the data being manipulated so thoroughly (presumably for Chinese internal political reasons) that there was no good way to tell for sure? Were the troubles in other emerging markets going to cross over to the developed economies, or were they isolated?

Like so many of our clients, we’re worried about the state of the world’s stock markets — every little bit of market turbulence leaves everyone’s stomachs at least a little bit unsettled. Quick downward jumps like this make us all wonder whether we’re seeing “just” a to-be-expected “correction”, or the first act of a replay of the Tech Crash of 2000, or the Financial Crisis of 2008-09. And seeing any part of our savings suddenly disappear into thin air like this makes us profoundly uneasy about our long-term plans and hopes: How can any of us even begin to think about retiring?

Over the last few days, we’ve all gotten our monthly account statements from our custodians. And as we write this, we’re busily reviewing and formatting our clients’ quarterly performance reports. Those reports all show that the Standard & Poor’s 500 Index (“the S&P”) was down more than 6% for the quarter — and just over 10% since its high point in May. Because all of our clients have broadly diversified portfolios, though, probably none of them have exactly the same result as the index. Owning not just the stocks of large US companies, but also small- and mid-sized US companies, foreign companies, real estate stocks, and at least some bonds and cash as well, will have changed the returns at least somewhat. Because bonds had a pretty good quarter, conservative portfolios did better than aggressive portfolios.

But what comes next? Will conservative portfolios continue to outperform? We can’t say for sure, of course. There are any number of pundits on TV and the internet who are happy to tell you that Market Indicator X is very clearly flashing warning signs, so it’s obviously time to get all your money out of the markets immediately! But there are just as many who will insist that Market Indicator Y is, by contrast, pointing up, up, UP!! We don’t subscribe to this style of market prediction: no matter how many times such predictions are shown to be misguided, because the markets really do move in a more-or-less “random walk” fashion, these pundits keep at their work.

So — is this a time to make a change, or not? A lot of investors feel that when markets are turbulent, they have to act: “don’t just sit there, do something!” is a common refrain. We think, though, that a prudently selected, prudently created investment portfolio and long-term plan shouldn’t be changed in the face of this sort of volatility. In fact, this is a perfect time to just sit here! Our friends at Azzad Asset Management point out that a market correction (down 10% or so) has, over the last 50 years, only turned into a bear market (down 20% or more) about 1/3 of the time — and the average time to a full recovery averaged about 10 months. This doesn’t necessarily mean that the stock markets will stabilize any time soon, and return to new highs by next summer, though we wouldn’t be particularly surprised.

A better question, we think, is this: When was the last time you reviewed your long term investment plans? How old is your Investment Policy Statement? If you have had significant changes to your financial situation, it may be time to review and revise that plan. In the meanwhile, here’s an article from The Motley Fool with some pithy reminders about markets and turbulence. For example:

  • President Obama was briefed after the market fell 10%. I guarantee you he’s not briefed after it rises 10%. Asymmetric emotional responses explain so much of why investing is difficult.
  • Daily market prices are determined by computers in New Jersey fighting to be a billionth of a second closer to exchanges than other computers. Business values are determined by 7 billion people waking up every morning trying to better themselves. If you bet on the latter and laugh at the former, you’ve figured half this game out.
  • If this decline keeps up, it could be as bad as the 2011, 2010, and 2004 downturns that no one remembers or cares about anymore.

We recommend, then, taking the daily market news with a hefty grain of salt — or, even better, turning it off altogether. Review your monthly statements, sure. And look closely at your quarterly performance reports. But remember that your prudent long-term plans are measured in years, not months.