Elevated stock market volatility, as we have seen the past two months, brings gloomy headlines and may elicit fear in some investors. Since the beginning of October, the U.S. stock market (Russell 3000 Total Return Index) has gone from being up nearly 11% for the year to up just 2% as of December 6th. Most of this decline has happened during a few sizeable down days in the market, which can be alarming. It is an impossible task to identify and quantify the specific causes of any market decline, but there are a few leading candidates this time:
- Concerns about tariffs and trade policy, particularly related to the U.S.-China relationship, and the impact on future U.S. and global economic growth;
- The Federal Reserve’s ongoing effort to raise short-term interest rates from the historically low levels that predominated since the Great Recession of 2008-09;
- The loss of market leadership from the FAANG (Facebook/Amazon/Apple/Netflix/ Google) stocks as these companies encounter greater economic and regulatory challenges; and
- Political uncertainty around the ongoing Mueller investigation of President Trump and his inner circle.
In summary, after a nearly decade-long bull run, the stock market appears to be in a period of digesting those gains and trying to ascertain what lies ahead for the global economy and corporate earnings. While unsettling, market pullbacks are par for the course and not uncommon.
- After prolonged bull markets, many investors begin wondering if the market is “overvalued.” By historical measures, however, the broad U.S. market appears to still be fairly priced. As of November 30th, the forward price/earnings ratio (which gauges how “cheap” or “expensive” the market is) for the S&P 500 is around 15.7. Compare that to the 25-year average forward P/E of 16.1, and relative valuations for the U.S. market are in-line with long term averages.
- Patient long-term investors understand that bouts of short-term volatility are inevitable, and don’t overreact to them. The average intra-year drop (referring to the largest market drops from a market high to market low during the year) has been approximately 14% for the S&P 500 Index over the last 38 calendar years. As of November 30th, the intra-year drop year-to-date for the broad U.S. market is around 10%. Since 1980, there have been 21 years in which there has been an intra-year drop of 10% or more, and in 13 of those years the index ended the year in positive territory.
Even after the recent decline, the broad U.S. market is effectively back to July 2018 market levels and is still positive for the year. Bull markets do not last forever and are inevitably followed by some degree of a downturn, the timing and magnitude of which are nearly impossible to predict. Times like these can even be construed as healthy, in that they help flush out excessive risk-taking and remind investors that the stock market’s attractive long-term returns do not come without sacrifice and some intermittent heartburn.
So, what is Dowling & Yahnke focusing on during this time of the year, amidst higher stock market volatility?
- Rebalancing portfolios. As various asset classes fluctuate in value, we place trades in client portfolios to maintain the targeted mix of stocks to bonds (i.e., if a portfolio has a 60% stocks/40% bonds Investment Policy mandate—and is now 57% stocks/43% bonds, rebalancing would bring the portfolio back closer to target). Rebalancing is a disciplined way to sell higher and buy lower, without having to predict the direction of markets.
- Tax-loss harvesting. For clients with taxable investment accounts, we scour for tax loss harvesting opportunities to offset current or future capital gains. Tax loss harvesting is a strategic way to minimize income taxes by selling investments with unrealized losses in order to offset current or future capital gains.
- Completing Required Minimum Distributions (RMDs). For clients over the age of 70½ (or with certain inherited retirement accounts), we are facilitating their remaining 2018 RMDs during the month of December.
- Coordination of charitable giving. For clients who are charitably inclined, the end of the year is quickly approaching. The creation and funding of Donor Advised Funds, donation of highly-appreciated securities, and Qualified Charitable Distributions (QCDs) from IRA accounts must be completed well before year-end. Please contact us as soon as possible if you wish to make any end-of-year charitable gifts.
Please feel free to contact us with any questions or concerns.