The stock markets’ abrupt dives so far in February have caused the S&P 500 to give back all of its 2018 gains to date. Although this can be disconcerting, short-term declines come with the investing territory, and a drop of 5%–10% or more can be a regular occurrence. The market’s extended multiyear run-up to record highs has recently been accompanied by historically low volatility, which makes it easy to understand how some investors could have become complacent.
As our clients have heard from us for a while now, our assessment of U.S. stocks is that they have been overvalued. So we are not necessarily surprised by volatility’s sudden return. The market drop is not an anomaly; the extended calm that preceded it was.
With that in mind, here are three things to remember:
- As long-term, fundamental investors, we have been cautious about the U.S. stock market’s high valuations for some time. Earlier this year bullish sentiment among investors hit new records despite U.S. stocks’ already high valuations. Then, last week, fears that rising wages and potential inflationary pressures could lead the Federal Reserve to more aggressively hike interest rate set in, contributing to the sudden selloff of the past few days. This cycle of fear and greed can create opportunities for long-term, disciplined investors. But in the short term, reactions to falling prices and more selling can produce a self-reinforcing dynamic. Eventually, once investors begin realizing that asset classes are at attractive levels, buyers come back to the market.
- We have been actively positioned for and managing our client portfolios to be resilient under a range of circumstances. We believe our forward-looking scenario analysis encompasses a broad enough range of positive and negative outcomes to weather periods of market uncertainty. Our portfolios are more focused on areas that offer relatively higher return potential and less focused on those areas where we see greater downside risk. Within stocks, this means we are tilted toward European and emerging-market stocks, both of which offer stronger earnings outlooks at lower valuations than U.S. stocks. In bonds, our positioning is based on managing the interest rate risk of core bonds while tilting toward areas of higher return potential, such as flexible bond and floating-rate loan funds. Finally, our diversified portfolios incorporate assets that don’t move in lock step with stocks or bonds. These non-traditional/alternative investments can be especially effective in balancing market downturns.
- The positive global outlook for economic growth has not changed. In our view, recent investor behavior illustrates how sentiment can become removed from fundamentals. Despite there being no significant changes to the positive economic and earnings growth backdrop, stocks in the United States and around the globe have tumbled. Put a different way, the stock market, and its zigs and zags, are not necessarily synonymous with the economic environment.
Uncertainty can cause angst, particularly when every newscast and headline seems designed to play up fears. But managing through uncertainty is what we feel we do best.
We appreciate the trust you place in us to manage your investments in support of your overall long-term wealth and life goals. If you have questions about your individual portfolio or how recent market moves might affect your financial picture, or want to discuss your risk tolerance level, please contact your Litman Gregory Advisor.
And if you would like to hear more about our thoughts on the market and our portfolio management, please join our Annual Outlook Client Webinar on Wednesday, February 14th at 10:00 a.m. Pacific time. To attend, register here.
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