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Special Market Update as of 2.5.18

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What’s Happened

  • 8% Sell-Off in S&P 500 and Dow Jones Industrial Index since the high reached on January 26, 2018[i]
     
  • 8% down on the Eurostoxx 50 index[ii]
     
  • 8% down on the MSCI Japanese Index[iii]
     
  • 9% off on the Standard & Poors China index[iv]
     
  • Gold down 1% over that same time-period[v]
     
  • Short-Term US government bonds relatively stagnant over the same time-period.[vi]
     
  • Long-Term US government bonds are also down over the same time-period.[vii]

Who HAS Been Winning The Last 6 Trading Days Since We Saw The Market Reach New Record Highs?

  • Investors holding cash. And they were long overdue after watching the US stock market return more than 35% through 1/31/2017 since Trump was elected only 15 months ago while their savings accounts were lucky to earn 1%.[viii]

 Key Observations

  • This sell-off (so far) has been very correlated across the globe. As you can see above, most major stock indices are off by about the same amount - ~8%. Usually, global markets don’t march in such lockstep to the downside or upside. No stocks have been safe in the last couple weeks.
     
  • Don’t judge sell-offs by points. This makes down days seem worse (on a percentage basis) than they actually are. The DOW lost almost 1,200 points today which was the largest point decline ever but was “only” 4.6% relative to a loss of over 22% in a single day on October 19, 1987 “Black Monday”.[ix]
     
  • Newspaper’s love to emphasize point drops because they sensationalize how bad things really were. (Doom and gloom sells newspapers).

Conclusions

  • Quick sell-offs like today help us reiterate the fact that you CANNOT react to most market sell-offs. They happen too fast. Rather, you have to allocate your investments in such a way that you are comfortable staying the course if/when a bad route happens. You can do this by selling into strength or anteing up in times of weakness (with a clear head). Reactionary investing is how emotions get the better of you.  
     
  • We have been selling into this strength (albeit a bit early) over the last year.
     
  • As many of you have heard us say, from an allocation perspective, we are on the far left side of the risk/reward spectrum currently for all our investors. That is, we are as “risk-off” as we can really justify being in light of each individual investor’s specific investment objective they have outlined for us.
    • Example - For an “aggressive growth” investor with an allowable stock allocation between 70-95%, we are closer to the 70% allocation currently as we have been concerned about stock market risk for some time now.

 What Now? Well, Nothing… Yet.

  •  An 8% drop is not enough for us to make any changes to increase stock allocations in a portfolio. This is a minor road bump in light of the above average gains seen in the market since the Trump election just 15 months ago.
     
  • We wouldn’t consider notable increases to our stock allocations until we see at least a further 25% decline in equities to bring purchase prices down to more reasonable levels. 
  • Why We Intend To Wait For a More Notable Drop Before We Ante Up On Stocks
    • We are approaching a record-breaking bull market streak in the US exceeded only once by the 90s tech boom (and 2000 bust). We know how that turned out.[x]
       
    • With data going back to 1900, the S&P regression to the trend line, Q Ratio, Schiller Ratio, Crestmont PE, and Market Cap to GDP ratios (all reputable long-term market valuation metrics) point to extreme US stock overvaluation.[xi]
       
    • Interest rates have begun to rise… many astute investors feel record low rates are the only thing buttressing current lofty stock market (and commercial real estate) valuations.
       
    • US stocks have outperformed most foreign indices by 100%+ in the last decade. This disparity will likely narrow over time.[xii]
       
    • Commodities are at their lowest relative valuation to US stocks since 1970 according to a simple numerator/denominator relationship of the S&P 500 to the S&P GSCI Commodity index.[xiii]
       
    • We have seen a notable shift from Fear of Loss to FOMO (fear of missing out) in our interactions with new prospective investment clients over the last 12 months.
       
    • Overall consumer savings levels are very low on a historical basis.[xiv]
       
    • Overall corporate debt (and government debt) relative to US GDP levels are very high on a historical basis. For instance, US gross government debt to GDP is over 105% currently. This is the highest ratio since just after WWII.
       
    • Margin debt levels are dangerously high. A disparity between the growth of margin debt and S&P 500 growth has reliably predicted the last two market meltdowns of 2000 and 2008.  [xvi] 

Why Invest in Stocks at All in Light of All This?

  • With a long enough time horizon, the danger of being completely out of the stock market is still higher than being in. Even for investors who put money in the US stock market in 1928 right before the worst recorded crash in history, they would still have recognized ~4% annualized returns on those stocks over a 20-year period ending in 1948.  [xvii]
     
  • Short-term market timing is a fool's game debunked by countless academic studies and rejected by world famous investors like Warren Buffet & John Bogle.

Some Questions for Your Advisor

  • If this market continues to sell off significantly which could create bargain prices, will you be in a psychological position to re-balance into more stock? If the answer is no and you are a client, please contact us so we can reduce the risk profile in your accounts now vs. waiting for what could be further declines in stock prices. If you work with another advisor, ask them this question. If you are a do-it-yourself'er, do some soul searching and formulate your strategy now vs. waiting for your emotions to get the better of you.

ENDNOTES

[i] As measured by price declines from 1/26/18 to 2/5/18 SPDR State Street SPY and DIA exchange-traded funds

[ii] “” “” State Street FEZ exchange-traded fund.

[iii] “” “” State Street EWJ exchange-traded fund.

[iv] “” “” State Street GXC exchange-traded fund.

[v] “” “” State Street GLD exchange-traded fund.

[vi] “” “” Vanguard BSV exchange-traded fund.

[vii] “” “” iShares TLT exchange-traded fund.

[viii] “” “” State Street SPY exchange-traded fund from 11/7/2016 to 1/31/2018.

[ix] https://en.wikipedia.org/wiki/Black_Monday_(1987)

[x] https://www.cnbc.com/2017/09/13/second-longest-bull-market-ever-aging-gracefully-but-investors-wonder-how-long-it-will-last.html

[xi] https://www.advisorperspectives.com/dshort/updates/2018/01/03/market-remains-overvalued

[xii] As measured by SPY returns vs. FEZ, EWJ, GXC, EEM returns over last 10 years as of 12/31/2017 and cited in our Year-end 2017 Newsletter.

[xiii] https://www.advisorperspectives.com/articles/2017/09/13/gundlach-im-not-really-bullish-on-bonds?channel=Capital%20Growth

 [xiv] Hoisington Management. (2018, January 9). Fourth Quarter 2017. Quarterly Review & Outlook.

 [xv]  Hoisington Management. (2018, January 9). Fourth Quarter 2017. Quarterly Review & Outlook.

 [xvi]  Mislinski, J. (2017, December 27). A Look at NYSE Margin Debt and the Market. Retrieved from https://www.advisorperspectives.com/dshort/updates/2017/12/27/a-look-at-nyse-margin-debt-and-the-market

[xvii] Dimensional Fund Advisors. (n.d.). Matrix Book 2017 (Historical Returns Data - US Dollars). Dimensional Fund Advisors.

 

Trevor Scotto