January and February have been trying months for investors. Stock markets around the world have continued to decline. It is the longest decline (7 months) since the financial crisis ended in March 2009. This inevitably leads investors to ask, “Are we going into another 2008?”.
Over the last 7 years, we have become used to stock markets appreciating with relatively little fluctuation. The current correction we are experiencing marks a return to the kind of fluctuation that is more normal for stock markets (historically speaking). The article we sent in last week’s newsletter titled, “Is Today’s Market More Volatile Than in the Past?” looks at the daily, weekly, monthly and yearly volatility of markets (using the S&P 500) since the 1920’s and concludes that “The last five years has actually been one of the least-volatile periods in history.”
Given the recent increase in market volatility, it is particularly important to maintain our rebalancing discipline.
If you look at portfolio returns from June 2010 to June 2015, PWL clients were earning between 7% and 10% per year on average (net of all fees). Throughout that time, we were rebalancing - taking gains on equity and buying more bonds to keep portfolios in line with each client’s investment policy targets.
Now rebalancing works in the other direction: Buying equity at low prices and selling bonds.
History shows that following corrections (declines of 10% or more) and bear markets (declines of 20% or more), the subsequent returns on stock markets are stronger than average - 10% and higher. In other words, buying equity at low prices today means that your expected return going forward is higher.
We are not heading into another financial crisis. The fluctuations that markets are currently experiencing are historically normal and they are the reason why investors make more investing in equity rather than bonds.