Is a Stock Market Correction Coming? Is It Already Here?

Arthur Stein Financial, LLC |
Recent stock market news has not been good. After declining 1.9% in the third quarter of 2014, the S&P 500 Index of US stocks declined another 2.5% from October 1 to 17. The index is down 9% since the all-time high in September. Last week was the fourth straight week of declines for US stock market indexes.
 
Stock market volatility increased and many other markets (international stocks, commodities) also fell in value.
 
It is time to worry?
 
 
Well, yes and no. And it depends.
 
We are overdue for a stock market decline of 10% or more. On average, the market declines 5% about three times a year, 10% (a “correction”) once a year and 20% (a “bear market”) about every three and one-half years. The last 10% correction was in 2011 and the last 20% or greater bear market was in 2008-2009.
 
There is no lack of bad news that might trigger a decline, including slow growth in Europe and China, Ebola, the continuing crises in the Middle East, tension with Russia and poor leadership in Washington
 
More fundamentally, prices for US stocks compared to earnings and other measures are either a little high or very high, depending upon the comparison used. Bonds are also at historic highs.
 
It’s not a pretty picture. So what should you do?
 
Most importantly, review why you invested in stocks (and mutual funds and ETFs that own stocks) and whether those reasons still makes sense. If your stock investments are long-term and the goal is to try to increase purchasing power, then stocks are still an appropriate place to invest.
 
Historically, stocks outperformed bonds and other investments over long periods of time.
 
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Stock market volatility (the constant increases and decreases) and sharp declines over short or long time periods are not a risk; they are a certainty. However, investors have been rewarded for the risks they took if they stayed invested in a well-diversified portfolio.
 
The table below illustrates that. There were many sharp declines, but larger market corrections were usually followed by larger market gains. That is why it made sense to stay invested.
 
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Also, there is some good news. The European Central Bank and China’s Central Bank are taking steps to stimulate growth, oil and gasoline price have declined, the US labor market is slowly strengthening, interest rates have declined (mortgage rates are the lowest in more than a year), consumer confidence is increasing and the US is poised to become the world’s largest oil producer.
 
Some investors try to move in and out of the market to avoid losses and increase gains. They are called “market-timers.” Those content to stay fully invested are called “buy-and-hold” investors.
 
Buy-and-hold investors usually outperform market-timers. Market-timers don’t know in advance what day the stock market will peak or hit bottom. Those dates are only known afterward. If someone does sell at the peak or buy at the bottom, it is almost always luck – not skill.
 
When market timers are out of the market, they usually transfer the investments into money market funds and then miss the dividend payments stock investments would have earned. The buy-and-hold investor continues to benefit from dividends, which don’t decline just because stock prices declined.
 
S&P 500 Index Funds currently pay dividends equal to 2% of their value, a 2% “dividend yield.” That is almost the same as the dividend yield on 10-year US Treasuries. Money market funds now earn less than 1%.
 
Finally, market timers incur expenses to buy and sell. In taxable accounts, they pay taxes on any gains. Buy and hold investors don’t incur expenses and don’t pay capital gains taxes until sales are made.
 
Stocks – and mutual funds that own stocks -- are appropriate as a long-term investment. Being invested in a well-diversified portfolio of stocks historically benefited investors who stayed invested during bad times. Diversifying stock investments with bonds reduced volatility and allowed for rebalancing. Market timing wasn’t needed.
 
Of course, past performance is not a guarantee or indicator of future performance.
 
Notes:
 
This is for educational purposes only. To learn more about the topics mentioned and if they are suitable for you, consult an appropriate professional. Tax laws can change at any time.
 
Any information provided in this presentation has been prepared from sources believed to be reliable, but is not guaranteed and is not a complete summary or statement of all available data necessary for making an investment decision. Any information provided is for information purposes only and does not constitute a recommendation.
 
Keep in mind that:
  • Past performance is no guarantee of future performance;
  • Investments involve the risk of loss of principal and earnings;
  • ETFs, mutual funds, including money market funds, etc. are not guaranteed in any way by the US Government, the FDIC, a bank or anyone else.
  • “Average annual return” evens out variations in the actual year-to-year returns.
  • ETFs, mutual funds and individual stocks and bonds fluctuate in value and there will always be times when they lose value.
  • None of the information provided by Arthur Stein is necessarily relevant to anyone’s particular situation. Situations differ among individuals and you should not assume that these generalizations or information apply to you.
  • Investments mentioned may not be suitable for all investors.

Arthur Stein Financial, LLC is registered with the states of MD, DC and VA. It is not registered with, nor is it required to be registered with, the Securities and Exchange Commission.