Wednesday, February 12, 2014

Recent Market Losses: How Concerned Should We Be?


Many investors viewed January 2014 as a pretty scary month. Over a period of just 12 trading days (1/15-2/3), the S&P 500 lost -5.76%. This spurred conversations online and in the media about the end of a long bull market run and even the possibility of a bubble. However, since the end of that tough stretch, the market has responded strongly and is now less than 1.5% off its all time high.

So what happened in January to cause such a response? Was it a concern about the health of emerging markets that caused such a scare, or perhaps the threat of rising interest rates? Did the uncertainty of having a new Fed chairman cause a pullback in the market, or maybe the concern of a terrorist attack in Sochi during the Olympics? These are all clearly issues that will obtain a good amount of short-term attention, but I’d contend that none of them were the root cause of the market decline.

History illustrates time and again that market volatility leads to memory problems for many investors.  Check out this chart (click to zoom in) itemizing all market corrections of 5% or more since the bull market began:


As you can see, although the market has increased in value from 676.53 on March 9th, 2009 to 1,819.75 on February 11, 2014, the S&P 500 has endured nine pullbacks of over 5% during that time frame. As illustrated by the lengths of the red lines associated with each correction, many of these market declines happened over a similarly short time span. Consequently, despite the S&P increasing in value by 169% over the last five years, the market has experienced a decline of at least 5% every six and half months on average. In fact, nearly a third of the months since the bull market began have seen the market decline, and by an average of 3% per month.  Considering this information, January wasn’t particularly unusual.

These periodic market pullbacks aren’t specific to the recent strong run. Historically, we typically see three stock market dips of 5% or more every year and one correction of more than 10% every 20 months. Yet, for some reason, the same conversations and concerns are repeated during every market correction. Investors wonder if this is the beginning of an extended market decline or even a crash. People consider selling their assets and taking their money out of the market. It is so easy to forget that we have seen similar circumstances in the past and that very rarely has anyone benefitted from selling. Refer back to the chart itemizing all market corrections over the last five years. There wasn’t a single market decline that didn’t recoup all value in a short period of time. Even the 20% decline that occurred in 2011 only took nine months to go from peak to trough to new all time high.

As a result, I’d suggest that the January decline in the markets is not only nothing to be concerned about, but it is expected and healthy. In fact, if you have done your homework as an investor and have a well diversified portfolio with a stocks/bonds ratio that matches your risk tolerance, you’ll be hard-pressed to find a market reaction that justifies dramatic action. Of course, there will always be market corrections (even the occasional crash), but as long as your portfolio is built to accurately match your investment time horizon, market values are likely to recover before the pullback is catastrophic to your retirement goals. Next time the market endures a short-term correction, remember it isn’t anything we haven’t seen before.


1 comment:

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