Many people are driven by fear and greed, and the stock market follows. These emotions were the primary drivers behind the dot.com bubble in the early 2000’s, the real estate bubble in 2006, and the Great Recession that began with aggressive mortgage lending practices, and the resulting losses that created a cascade of bank and brokerage firm failures.
It’s always easy to look back and recognize that we were overly greedy or fearful after the fact, but when you’re in the moment, it’s difficult to be objective.
I’ve thought about this as I’ve watched Fed Chair Jerome Powell and the rate-setting Federal Reserve criticized by our president and others for the quarter-point rate hike in December, followed by the June announcement that the Fed would not only back away from interest rate increases in 2019, but may actually cut rates today at their July policy meeting.
Unemployment in the US is near a 50-year low, and reports in early 2018 indicated the economy was expanding. Both were reasons given by the Fed for its increase in December. But revised government data released last week showed the gross domestic product, a measure of the goods and services produced, was up 2.5% for the fourth quarter of 2018 – lower than the 3% growth target set by the administration. A significant portion of the growth was due to consumer spending, while business spending declined. And inflation is running below the Fed’s 2% target, possibly due to some goods and services, like health-care, that haven’t been rising as quickly over the near term.
In client meetings over the past few weeks several people have expressed concerns that the US economy may have run out of steam, and the stock market may be overdue for a correction. We’ve seen the Dow Jones Industrial Average climb from 6,500 in March 2009 to over 27,000 as I write this blog. The 14% decline in the S&P 500 in the fourth quarter of 2018 shook many people up, but stock prices bounced back when Powell indicated they may cut interest rates to keep the economic expansion going. To some, it appears that pressure is being applied to the Fed to lower rates only to keep the stock market rolling on.
Are we getting greedy? Are we executing policy decisions that will cause the economy to overheat, and leave us with a more severe market correction when it eventually arrives? Should we be doing something now?
If you’ve read our TAAG blogs in the past, you know we don’t try to predict the future. Even when everyone ‘knows’ a correction is due, we know from experience that getting out of the market in anticipation of a fall, then trying to determine the right time to get back in before the next recovery, is a high risk move in both directions.
Sitting on the sidelines creates losses in the form of opportunity costs. Investors who stayed in cash or cashed out of the market after the unsettling fourth quarter market drop last year have missed out on 20%+ returns in large, US companies so far this year. International and real estate stock returns have been healthy too. And research has shown that once out of the market, investors are reluctant to get back in until they feel safe – well after the unpredictable gains that come close to the bottom of most corrections.
There are better ways to lower your risk of loss. Knowing how much you should have invested in stocks vs. bonds and cash is the first step. Understanding that you’ll need to take some risk in order to meet your goals and recognizing how much you can see your investments decline in value without bailing out is key.
Once we know how much you should hold in stocks, we then work to reduce the risks that don’t reward you over the long run. An investor with $100,000 invested in one company is taking a much greater risk than someone with the same amount invested in an S&P 500 fund, for example.
Not having everything in large, US companies is another way to reduce your risk of loss. We know that countries and companies across the globe experience different growth cycles based on their locations, ways of doing business, and products they produce. The ‘lost decade’ of the S&P 500 taught us that a portfolio made up of large, familiar companies based in the United States may make us feel safer, but it doesn’t necessarily make us wealthier.
A rate cut is probably built into today’s stock prices since it’s been discussed for months, and a surprise announcement about tariff negotiations might spur a correction. But if we hold our fear and greed in check and use the ups and downs of the market – when they inevitably come – to sell high and buy low using a disciplined approach, none of it matters to your long-term financial success.