Nervous About the Stock Market?

     The stock market affects my life, and I bet it affects yours as well. Those of us without a pension have our "pension" (if we have one at all) in the form of an IRA or 401K, which is likely invested primarily in mutual funds holding stocks and bonds.

     But even for those who do have a pension ... where do you think the pension fund gets the money to pay your benefits? Largely from the stock market. One of the most significant holders of stock in America is CalPERS, the pension fund for California state, school and public agency employees.

     (Honestly, that's one of the things that makes me nervous about Bernie Sanders. I am no defender of Wall Street ethics, but I can only think that if the president were to go to war with Wall Street, as Sanders wants to do, one of the casualties would be my pension. So I'd be more comfortable with the reformist approach of Hillary Clinton who, for example, proposes the elimination of the egregious tax dodge called "carried interest" that allows executives to pay lower taxes on their income. Now, if we could only do something about those ceo's who ... oh, don't get me started, that's another subject.)

     Be that as it may, since the beginning of the year the stock market has swooned, making me more than a little nervous about my IRA. So I turned to my financial guru, Jeremy Kisner of Surevest Wealth Management in Phoenix, to gain a little perspective on the situation. Here, with his permission, I've distilled some of what he has to say to us retirees:

What Is Going on with This Market?

     

     Last year volatility in the stock market returned after several years of steady gains. The VIX, a measure of volatility also known as a “fear gauge”, has recently hovered between 20-30, representing 60 percent more volatility than a year ago. However, by historical standards, this is not unusual. From 1990 through 2014, the VIX spent nearly a third of its time between 20 and 30. Still, the uptick in volatility has been unnerving for many investors.

     The major stock market averages were essentially flat in 2015, while oil and other commodities were crushed. One of the culprits was the Chinese economy. But the headlines coming out of China obscure the fact that a lot of the U.S. economy is on fairly steady footing. We have record car sales, rising home values, low unemployment, low commodity prices for producers and low gas prices for consumers, strong corporate balance sheets, increasing profit margins, and decent retail sales numbers. Indeed the U.S. economy showed enough strength for the Federal Reserve to raise interest rates in December.

     What everyone wants to know is: Will markets continue to fall? When will they bounce back? Is this a time to get more conservative or more aggressive?

     

     For the answer, we can either look at history, or the predictions of market analysts. I try to ignore the analysts. Why? An article Strategists: Full of Bull reviewed 186 market forecasts over the past 19 years and reported the average forecast was not only wrong ... it was more wrong than if you had made no prediction at all!

     Market analysts have a bullish bias, with only 9 percent predicting a down market in years when the market was down. So far, this year is no exception. Analysts have an average forecast for 8 percent growth. Who knows? That may come to pass. But so far the lousy forecasting ability of these experts appears to be intact. So most investors are best served by ignoring forecasts by people in the media who espouse their convictions with authority -- and end up being wrong.

 

     Stock market corrections are actually a normal part of equity investing. The S&P 500 has declined 10 percent or more 29 times from 1935 through 2015. The average decline was 21 percent, occurring once every 2.75 years. In hindsight, there are explanations for these corrections. Yet trying to predict when the next one will occur is impossible. By the way, the average rebound from those declines has been 68 percent.

     So let's look at what has actually happened over the past 70 years. The stock market has ended up declining in more than half of the years when it was down in January. The average yearly decline was 3.2 percent. But that doesn’t sound too scary when you consider that we are already down about 10 percent year-to-date. One interesting point to add is that the worst January of the past 70 years was 2009 when the market dropped 8.6 percent in January. Stocks continued to sell off for a couple more months, but then rebounded to end the year up 26 percent!

     Stock market corrections are scary and unpredictable. Market analysts use all kinds of statistics to explain (in hindsight) what happened. The reality of the situation is financial markets are primarily driven by investor psychology based on short-term events, and it’s very difficult to determine how greedy or scared people will get at any moment.

     Imagine if you had built a family business over the course of several decades. Today, your company is growing and highly profitable. Would you sell your company (or part of it) and buy it back every few months? Of course not. Yet today, investors can buy and sell shares in a nanosecond with very little transaction costs. This is why we have so much volatility. The short-term value of your investment portfolio is more reflective of investor sentiment than the long-term value of the underlying assets.

     It is helpful for investors to understand that market returns over the long run come down to two things: jobs and earnings. People will continue to buy products and services as long as they have jobs. Some people question the quality of jobs and the accuracy of the numbers, but job growth has exceeded expectations for the past year, and the unemployment rate is down to a healthy 4.9 percent.

     Earnings of publicly traded companies are historically traded by investors at a multiple of 15 times. This means if a company earns $1 per share, its stock trades at $15 per share. When the company grows its earnings, there is typically a corresponding increase in its stock price. The U.S. stock market is currently valued at about 15x earnings, near its historical average. Investors are usually rewarded for selling when earnings multiples rise significantly above their long-term averages and for buying when they fall below. In addition, having a globally diversified portfolio enables us to invest in markets that trade at discounts to ours as well as into asset classes that are out of favor (or, "on sale").

     Will companies be able to continue to grow and hire more people? Consider this: despite what may happen in the next couple of quarters, the global population is expected to increase from 7.3 to 9.6 billion people between now and 2050. That is a lot more customers to buy cars, computers, food, clothing and everything else. The world is growing, and so the companies in your investment portfolio are likely to find ever-more-profitable ways to serve their growing client bases.

     The most important part of successful investing is to find a viable strategy and stick with it. The worst thing to do is to second guess yourself because of a disappointing period. If you just stay the course, you can probably be “average”.  In most things in life we do not strive to be average. However, the average returns for stocks, bonds and balanced portfolios are the safest and surest way to grow your retirement portfolio over the long term. Most people think in a time horizon of weeks or months; and the common way people predict the future is to look at recent experience and expect it to continue into the future. The reality is that financial trends reverse themselves abruptly, making it hard to see any pattern in the time horizons that most investors consider. As an investor you have to train yourself to think in terms of years, even decades.

     Also, sometimes the “averages” seem suspect because we assume that yearly stock and bond market returns would be clustered around the average. But that is not the case. Market returns in any given year are rarely close to their long-term averages. For example, the average return for stocks from 1926 to 2014 was 10.2 percent. How many times during those 89 years do you think the annual return fell between 8 and 12 percent? Incredibly, that only happened six times.

     So you cannot expect an “average” return this year, or next. You may get much more or much less. But history has shown that over time, average returns will make your retirement plan work, even if in any given year, that may be hard to see. But as I covered in more detail in my article When Will You Need The Money? with time comes predictability … and averages.