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Market Commentary 12/31/2018

Markets, Emotions, and Common-Sense                                                       

This past quarter was tough on all our portfolios.  Your December portfolio statements may make you feel uneasy, concerned or second guessing why you should stay the course.  If we were investing only for the past 90 days and not the long-term, there might be some cause for concern.

The fourth quarter began with the S & P up 10.56% ending the year down 6.2% including dividends.  The Morningstar Moderate Target Risk Index (60% Equity/40% Bonds) ended down 4.75% for the year.  Market downturns have different themes as to why they go down, but this is in fact very normal.  The headline news deems a 4% decline these days as a “rout” in the markets.  We see it as an adjustment in the market.  This chart, from American Funds January 2019 “The Capital Ideas” helps us to understand:

As you can see above, the average market downturn lasts less than a year.  This doesn’t mean that it can’t last longer.  Historically, between 2000 – 2002 we saw the market drop 37% over three years.  The markets recovered to the levels we’re seeing today.  Since then, the markets have more than doubled.  Having a long-term perspective is key to investment success.

The return of volatility in 2018 to our portfolios is not a new discovery.  Investors are human beings with the ability to make irrational decisions regarding investment decisions.  We can learn from Richard Thayer, Nobel Memorial Prize winner in Economic Sciences, for his work in behavioral Economics.  He studied investor behavior and how the stock market responded to stock market movements.  In behavioral economics it is well known that people attach too much weight to the most recent information.  This is known as recency bias.  Capital Group summed up Thayer’s findings, with helpful information for investors:

  • Investor biases can affect how the stock market behaves, leading to extreme and varied movements in stock prices.
  • Investors who focus too much on the short term can miss out on opportunities.
  • Stocks react differently to news.  It takes research and investment experience to analyze how they might react. [1]
  • Emotions will always be a part of the investment experience, and what is most important is how you handle those emotions.  We believe the best way is through commonsense thinking.  For example, when markets are falling as they did in December, stop and ask yourself a few questions:

    • Do I need all my money today?  If you answer ‘yes’ you shouldn’t be in the market.  If your answer is ‘no’, then ask yourself:
    • Do I have adequate money available for my cash flow needs to last through a downturn?
    • Is my portfolio constructed to withstand the worst of the downturns?

    If you can answer ‘yes’ to the last two questions, you should be able to weather the volatility.  This doesn’t mean this part of the investment experience is easy, it means you are positioned appropriately to handle the volatility.  Volatility is our friend, but we don’t know it at the time it’s experienced.  Investors have known that the market advance would eventually run out of gas.  We are beginning to see signs of low fuel as the global economy has slowed, but the market is still growing.  Globally, easy money times have passed by and we are now seeing a tightening of monetary policies.  Corporations throughout the world have borrowed heavily during this easy money time-period to buy back their stock and in turn are carrying higher debt heading into the next recession. 

    In preparing for the next recession, we shortened our durations and are now shifting to higher quality bonds given the higher debt load caused by the monetary stimulus.  Your portfolios will reflect this with trade confirmations you may receive in the weeks ahead.  We remain optimistic in holding and adding to developed international and emerging markets for the future.  The U.S. markets remain steady after the sell-off in December but are not cheap.  We have pared back holdings over the past few years in taking profits.

    Over the past year we have discussed the importance of diversification, how portfolio construction prepares for changes in market direction, taking profits when prudent, and how the impact of risk can play out in your combined portfolios.  Our strategy and philosophy have always been building portfolios that work in good or bad markets. 

    We appreciate your continued trust and confidence as we move forward.  Don’t let the emotions of the moment distract you from your overall objectives.  We sincerely believe that staying the course is the right plan.  We need to stay focused not solely on the markets but on a well-diversified portfolio, which has proven to reduce volatility over time.     

    Please call us with any questions or concerns you may have.  We look forward to our next conversation.

    Thomas L. Menzel, CFP® President/Principal Owner


    Laura A. Biermann, CFP® Vice President/Principal Owner


    [1] January 2019, American Funds “The Capital Ideas”


    IMPORTANT DISCLOSURES: The opinions presented in this communication are subject to change without notice and no representation is made concerning actual future performance of the markets or economy. Information obtained from sources is considered reliable but is not verified. The research and other information provided herein speak only as of it date. We have not undertaken, and will not undertake any duty to update the research or information or otherwise advise you of changes in the research or information. Performance information presented is not an indication of future results and index data is provided for market reference purposes only. This is not an offer to buy or sell or the solicitation of an offer to buy or sell any security/instrument or to participate in any particular trading strategy. This document is the property of Legacy Financial Advisors and is intended solely for the use of the Legacy client, individual, or entity to which is addressed. This document may not be reproduced in any manner or re-distributed by any means to any person without the express consent of Legacy. This material is for educational purposes only. Mis-transmission is not intended to waive confidentiality or privilege.