Is a Stock Market Correction Coming? No Doubt About It! Part II.

Arthur Stein Financial, LLC |

"Everything old is new again."
  
Many stock market commentators and investors are upset about recent declines and poor performance this year. The US markets declined four straight days through Friday.

The S&P 500 Index declined 3.2% on Friday and 5.8% for the week. The S&P 500 Index (not including reinvested dividends) is down 7% from its latest high.
  
My November 2013  blog discussed the possibility that a major stock market correction (a greater than 20% decline or "bear" market) was going to occur at some point in the future. I said that a 20% decline was definitely going to occur.
  
Usually, I never predict the stock market. And 2013 had been a good year for stocks. When I wrote the blog, the S&P 500 Index was up 25%. So why was I comfortable predicting a major decline?
  
Well, historically, stock market corrections are always coming. There has never been a time when a market correction wasn't in our future. 
  
On average, the stock market - as measured by the S&P 500 Index - has declined

  • 5% more than three times a year
  • 10% about once a year
  • 20% about every three years.

My blog post didn't discuss when the decline was coming, just that it would at some point. Almost two years later, the stock market still hasn't had that major decline. In fact, the market hasn't declined 20% or more since the great recession of 2007-09. So we are even more overdue for a decline than in 2013.
  
Well, if a decline is coming, why stay invested in the stock market?
  
Investors need to take into account not just declines but also advances and long-term returns. Looking at the subsequent recoveries reveals that the average recovery increases in proportion to the decline that preceded it. Over long periods, investors who stayed invested and took the losses were compensated by increases in the value of their stock market investments.
  
Even the current declines may not be as bad as portrayed. Despite this week's sharp decline, investors in an S&P 500 index funds have seen their investments increase over 1% this year. That's because of reinvested dividends. The index increased over 7% over the last 12 months.
  
The last 10 years included the greatest stock market decline since the great depression. Yet the market still showed solid gains for long-term investors. The average annual return for the S&P 500 over the last 10 years was 7.9% per year. Bonds returns over the last 10 years were in the 4-6% range.
  
It is important to note that past performance is no guarantee of future performance. This information is not a complete summary or statement of all available data necessary for making any decisions and does not constitute a recommendation.
  
Stock market volatility (the constant increases and decreases) is not a risk; it is a certainty. There will always be volatility, often by large amounts.
  
Trying to profit by selling stocks before  market declines and then buying after they declined produces more loser than winners. Investors who try to buy before a market advance or sell before a decline are called "market-timers." Those content to stay fully invested are "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 usually luck - not skill.
  
Market-timers often sell before or after the market peaks, missing some part of the gain. They buy back before the market bottoms or after the market begins recovering, incurring some part of the market loss. Or maybe they never reinvest in stocks.
  
Market timing causes other problems. Being out of the market also means missing dividend payments. At today's prices, an S&P 500 Index Fund pays dividends equal to 2 percent of its value, a 2 percent "dividend yield." A market-timer's investment could be in a money market fund earning less than 1 percent. The buy-and-hold investor continues to benefit from dividends, which don't automatically decline because of declines in stock prices.
  
Finally, market timers are incurring expenses to buy and sell. In taxable accounts, they pay taxes on their gains. Buy and hold investors don't incur expenses and don't pay capital gains taxes until sales are made.
  
Historically, stock investors did not need to buy and sell to make a profit. They only needed to buy and hold a well-diversified portfolio for a sufficient period of time.
  
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;
  • Stocks, ETFs, mutual 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 applies to you.
  • Investments mentioned may not be suitable for all investors.