Marketline Monthly – March 2018
This month we are deviating from our normal format to bring you some history around market volatility. We have received a surprising number of comments about the stock market’s gyrations lately – and we want to dampen any concern about this behavior. Because: it’s normal.
Most likely, investors have become used to 2016 and 2017, when volatility was historically low. In particular, 2017 broke records for stability. Even 2016 had a few rocky months. But ‘normal’ is not stable. Since 1900, stocks have had 5% declines every 120 days; 10% declines (a ‘correction’ in Wall Street parlance) every 357 days; and 20% bear markets every 3.5 years. Two percent daily gyrations in prices are as common as dirt; to put that in perspective, at Dow 23,000, a two percent move amounts to 460 points! In the period since 1928, 5% corrections happen much more often, roughly every month or two. For the minor moves (yes, we consider 5% to 10% declines “minor” since they happen so often), the time from peak to trough to start of recovery is three to six months. Critical to the picture, though, is that after these declines, once recovery starts, it’s strong. The median return for stocks 12 months from the start of a decline is 13%.
A reliable lesson here is to eschew market timing. You may be able to duck a decline, but then in the flush of success, you won’t re-enter stocks, so you will miss the recovery. Unfortunately, the best days in the stock market often come after the worst days. Miss a few of those good days and you will cut your return from stocks in half, or less. This outcome is just unacceptable: why put up with the volatility of stocks if timing destroys your return?
On the other hand, if volatility causes an investor to lose sleep, he shouldn’t own so much, or maybe any stock. Instead, adjust portfolio allocation to a lower risk profile, and reduce expectations and/or living standards to match the new lower return. And, nothing in this treatise says investors should not engage in risk mitigation. We use risk mitigation in many ways constantly: we pare large positions after they have done very well to book some profit and rebalance into bonds or cash; we enter new stocks with partial positions to ease the risk that we are buying too early; we sell entire positions once they reach high valuations, often swapping into lower risk issues with higher dividend yields if suitable; if we find an entire industry that we think is cheap (apparel companies in 2016/17, auto parts makers in 20014/15, tool makers in 2009) we occasionally buy small positions in many such stocks, rather than betting on just one. Risk mitigation may diminish return but it hedges against more serious bear markets such as we saw in 2008/9.
To point, stocks are down about 9% or 10% from the peak in January this year, depending on exactly which index is the measuring stick. In the context of a very long bull market, that’s a pretty light price to pay. Volatility is not likely to go away in the next week or month, though it should abate. Soon, investor focus will shift to earnings. Earnings may not meet analyst expectations – in fact we think that’s the likely scenario and the source of more volatility – but eventually we will get back on track, if even at a lower rate of return.
Long bond yields declined, and once again we are looking at a 3% thirty year Treasury. Evidence that technology is restraining price inflation mounts by the day, supporting the ‘low rates for longer’ thesis, along with all the other factors we mentioned last week. On the shorter end of the curve, however, rates continued to inch up. Most particularly, the London Interbank rate, LIBOR, has spiked recently, causing fits in the adjustable rate mortgage and commercial lending markets, where many loans are tied to LIBOR. Risk mitigation on the bond side largely consists of upgrading credits and positioning appropriately on the yield curve. With US government agency bonds and even some municipals yielding well in excess of 3% now, we occasionally have the opportunity to sell corporate issues to swap into these higher quality issues at very little yield cost.
Marketline Monthly is produced by Cascade Investment Advisors, Inc. We specialize in value investing for individuals. We apply our approach across markets, looking for low-priced securities that offer above-average potential. We use imagination and hard work to bring performance and personal service to our clients. To learn more, contact Michelle Rand at 1.503.417.1950 or 1.888.443.9015; email to Michelle.Rand@cascadeinvestors.com. Our website is www.cascadeinvestors.com. A full list of stocks we invest in is available on request; mention of specific securities is not investment advice; such investments may or may not be profitable.