- The market has been particularly volatile over the last six sessions. What should investors do?
- Follow Alexander Green’s time-tested advice for wealth creation.
It’s certainly been an interesting seven days for the stock market.
Last Wednesday, the S&P 500 hit a new all-time high. But over the last seven sessions, it has plummeted 16%.
The Dow had its biggest point drop in history yesterday. And it is on track for an equally large drop today.
This has already been the single worst week for the market since the financial crisis.
The Dow, the Nasdaq and the S&P 500 are all in correction territory, along with markets in Europe, Japan, China and Hong Kong. (And they got there at the fastest pace in more than 70 years.)
And that’s the good news.
Just kidding. There has been little news for equity investors to celebrate lately.
But let me provide a bit of perspective.
Yes, the Dow had its biggest point drop in history yesterday. But it was hardly historic in percentage terms, a bit over 4%.
On October 19, 1987 – Black Monday – the market plunged 22.6% in a single day. That was a doozy. I witnessed it from my desk on Wall Street.
And the 12% sell-off in the market over the last week? That takes stocks back to where they were in October.
What would investors be doing with their money today if the market had been flat the last five months? Probably something different from what they’re contemplating today.
Why has the market keeled over?
We all know the backstory by now. Investors initially felt assured that the coronavirus outbreak in China would be contained.
Now they feel like it won’t be… indeed that it can’t be.
Don’t waste a minute listening to health or financial experts telling you how far and fast this epidemic will spread. That’s all guesswork.
What has become increasingly clear is that the virus is moving fast and is easy to transmit, including by people who aren’t showing any symptoms.
If fear continues to spread, folks will travel less, go out in public less and spend less. If their customers spend less, businesses will spend less too.
And if everyone spends less, corporate profits will fall. The stock market – as we’ve seen over the last seven sessions – is all about the future direction of profits.
What should you do now? The same thing I suggested last month.
In early January, I wrote a Liberty Through Wealth column titled “What Sophisticated Investors Should Expect in 2020.”
Since I wouldn’t change a word of my advice, I’ll repeat what I said…
Today I’ll reveal the unvarnished truth about how things will turn out in 2020.
However, it’s a bitter truth you may not want to hear: No one knows.
That may sound disappointing – or just plain odd – coming from someone who gives investment advice for a living.
After all, people in my business are supposed to have strong, well-reasoned opinions about economic growth, inflation, interest rates, currency values, commodity prices and the outlook for the market.
The problem is that those opinions are worth exactly what you pay to hear them: nothing.
Why? Because economic forecasting and market timing can’t be done accurately and consistently and, therefore, don’t add value.
Let’s take a short trip down memory lane…
A decade ago – with the nation having just undergone the worst economic downturn since the Great Depression – who predicted that we were at the beginning of the longest economic expansion in U.S. history?
No one. Economic pessimism was rampant.
Since the market had already taken a significant bounce off the bottom in 2009, who predicted at the beginning of 2010 that large cap stocks would more than triple and small cap stocks would more than quadruple in the decade ahead?
No one. Instead, the widespread consensus was that investors needed to adjust to “the new normal,” far-below-average stock market returns going forward.
A decade ago, with interest rates near zero, who predicted that 10 years later rates would be negative on more than $14 trillion worth of global bonds?
No one. Instead, the dominant view was that ultra-low rates were a short-term aberration and investors should expect them to quickly “normalize” (i.e., return to historically higher levels).
Another dud forecast. Good thing we didn’t buy into any of them.
At this point, some investors will say, “Well of course no one knows for certain how the economy and the financial markets will perform, but you have to guess.”
No. You don’t have to guess. That’s my whole point.
As an investor, you want to avoid guesswork as much as possible and use an approach that gives you the highest probability of success.
How? By asking a fundamental question that is at the heart of sophisticated investing: “Given that no one can tell me with any certainty what the economy or markets will do, how should I run my money?”
Here is the answer based on my 35 years’ experience as a portfolio manager, investment analyst and financial writer:
- You adopt an asset allocation that allows you to capitalize on the uncertainty inherent in financial markets. (Subscribers to The Oxford Communiqué can find my recommended asset allocation model here.)
- You outperform the market not by correctly predicting its short-term movements – a mug’s game that no one wins – but by selecting and owning companies that give substantially higher returns. (See our recommended portfolios for examples.)
Longtime readers understand my agnostic approach to the future – and the market-beating success we’ve had with it.
However, tens of thousands of readers have only joined us in the last few months – thanks in part to the generous endorsement of longtime subscriber and bestselling author Bill O’Reilly – and might benefit from a primer.
So here it is…
I do not recommend stocks because the economy is strong, corporate earnings are up, taxes are down, the market is in an uptrend or Donald Trump is in the White House.
I recommend stocks because more than two centuries of financial history demonstrate that a diversified portfolio of common stocks – or, better yet, uncommonly good stocks – is the best way to grow your wealth and protect it from the ravages of inflation.
The trade-off for these much-higher-than-average returns is that equity investors have to endure occasional and unpredictable bouts of neck-snapping volatility.
(See 2007 through 2008 for details.)
However, a broadly diversified portfolio lessens your risk and volatility. So does asset allocation. (That means spreading your investment capital among non-correlated asset classes, including high-yield and high-grade bonds, real estate investment trusts, and Treasury Inflation-Protected Securities.)
To further reduce your downside, I recommend trailing stops behind most individual stock positions.
We’ll talk more about each of these issues in the weeks and months ahead.
The important thing to recognize is that, while the economy and the market will often surprise you, stocks are the greatest wealth creator of all time.
And if you buy quality, asset allocate properly, diversify broadly, reduce your investment costs and minimize Uncle Sam’s tax bite, you’ll do just fine.
Moreover, when the going does get rough – as it will from time to time – I’ll be here to remind you of first principles… and talk you off the ledge, if necessary.