Concerns about potentially higher inflation, among other things, spooked the markets last week. Stock prices fell, ending with a –2.1% day on Friday. Yesterday, markets opened briefly higher and then fell steadily. There was a sudden drop mid-afternoon, and overall the S&P 500 was down 4.1%. The market’s volatility continued this morning, with prices sharply lower and then higher, but no overall trend. At noon prices were almost unchanged from the opening.
This has been an unexpected market break, but it is in no way a severe or unusual one…except by comparison to the new-highs-every-week trajectory of the last few months. The one-day decline on February 5 was only the 15th largest of the last ten years. For the year to date, we’re now in slightly negative territory, down less than 0.5%. At this point, we have given up less than one-third of the Trump Trade market advance since Election Day on November 7 of 2016.
What does this decline mean and what should we do?
For the last several years, this has been a market that has ignored most bad news while pricing in perfection—of economic policy, of earnings, of investment practice. Such periods of risk-seeking are a typical feature of late-cycle bull markets, when ignoring risk and chasing returns can be very profitable, right up until it is suddenly very costly.
What is happening now is an abrupt reassessment of risk and pricing. In the long run, that is healthy. What is not happening is an actual economic decline, either in the US or the broader world economy. That suggests (but does not guarantee) that this is unlikely to be the beginning of a market panic like 2008-2009. That bear market was driven by a genuine economic catastrophe—widespread defaults on mortgage-backed securities, leading to the collapse of the financial sector and a global recession.
“An intelligent investor knows how to manage risk.”
We always pay attention to risk. We tilt towards less volatile securities and managers in our investment strategy. For the last several years, we’ve included a dynamic cash component in our portfolios. Following our valuation metrics, we raised our cash target at our Investment Committee meeting on January 11. As most of you recognize, our investment posture is more defensive than that of many other advisors, and that positioning is designed to reduce your downside exposure during a market decline.
The five voting members of our Investment Committee have more than a century of combined investment experience. We’ve seen market declines like this dozens of times over very long careers. We know what to do during disordered markets—maintain our long-term focus, pay attention to valuation, and avoid excesses of greed or fear.
“Cash combined with courage in a time of crisis is priceless.”
We are nowhere near a crisis yet. It is business as usual here at TGS. We’re watching the market closely. For investors whose cash positions are significantly above or below target, we will make some limited adjustments.
What might cause us to make a more complete move from cash back into equities? Much worse news leading to much lower prices. But if things do get a whole lot worse, we’ll know what to do—seize the opportunities, and buy when everyone else is selling.
In the meantime, let’s continue to enjoy the afterglow of the Philadelphia Eagles’ unlikely Super Bowl triumph over the New England Patriots, and be of good cheer.
As always, please call if you have questions, or if we can help in any way.
By James S. Hemphill, CFP®, CIMA®, CPWA®/ Managing Director & Chief Investment Strategist
Jim has been a CERTIFIED FINANCIAL PLANNER™ professional since 1982. Jim specializes in complex wealth transfer and retirement transition strategies and coordinates TGS Financial’s investment research initiatives.
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