Many investors I know have been watching the stock market volatility over the past few months with a sense of anxiety and dismay. During the fourth quarter of 2018, it became clear that the stock market was going to take a breather from its unprecedented bull run over the past nine years.
Technically speaking, a stock market correction is when stocks drops by 10% or more from a recent high. By contrast, a bear market is when stocks drop by 20% or more from the peak.
On Christmas Eve 2018, the S&P 500 Index hit a bear market when it crashed down to 2,351 after reaching 2,940 in late September. Now it didn’t stay in a bear market for very long as stocks bounced higher in the following weeks and continued to rise through early 2019.
The fact is, many stocks have already declined by more than 20% by the time October 2018 came around. December 2018 was particularly painful as fear and panic forced investors to question the sustainability of the bull market.
Issues Concerning Investors
The increased volatility and decline we witnessed in late 2018 was due to a number of factors. By almost any measure, the economy was expanding at a healthy pace throughout 2018.
Instead of looking in the rear view mirror, the stock market is forward looking so it is more concerned about what’s to come in the future.
The Federal Reserve raised interest rates a total of four times in 2018 and it may continue to raise interest rates in 2019.
What does all this mean? Higher interest rates make borrowing more expensive. This will include credit cards loans, home equity loans, etc.
Nobody knows what the central bank will do. However, if the economy shows signs of slowing, raising interest rates will cause it to slow down further.
The Inverted Yield Curve
Investors are concerned about an inverted yield curve. This occurs when short-term yields are higher than long-term yields for the same type of bonds.
Having an inverted yield curve has been one predictor of recessions in the past. We are not there yet, but the yield curve today is relatively flat. This may be a result of long-term interest rates falling more than short-term interest rates or short-term rates increasing more than long-term rates.
Pressures on the Stock Market
Trade tension with countries around the world, specifically China, has worried companies big and small. Imposing a higher tariff on goods by trade partners will undoubtedly hurt economies around the world.
The Tax Cuts and Jobs Act of 2017 provided a boost to corporate profits, but the excitement did not last for a very long time. Many publicly-traded companies used the tax savings to buy back more stock. So far, the economic expansion that we were hoping for due to the tax reform bill has not panned out.
Another key driver of pressure on the stock market is corporate earnings. Lowering 2019 profit guidance by some large multinational corporations was a main contributor to the stock market decline in late 2018. Chances are that corporate profits will increase more slowly going forward.
What Should Investors do?
In times of uncertainty, the worst thing an investor can do is panic and act like the world is ending. I know the 24/7 news cycle can get overwhelming and make you nervous, but you need to understand the basics of investing and stick to your long term goals.
Market declines are inevitable. Don’t worry about things that are out of your control.
Given that the market has been on an upward trajectory since 2009, it should come to no surprised that it’s needs to take a breather. It may be time to rebalance your portfolio and increase your holdings in value oriented and dividend paying stocks.
The bull market has stretched the valuation of some fast growing companies. During times of volatility, there is usually a “flight to quality” — which is an event that occurs when investors sell what they deem as high risk investments and purchase safer ones. When that occurs, it may push risky stocks lower.
In time of economic uncertainty, I would reevaluate big ticket purchases. For example, if you are planning to spend money on a new car or to remodel your kitchen, be sure that you won’t need to sell your investments to pay for those expenditures.
Stay Calm and Focused
For people who are still working or continue to generate income, stock market declines presents the best opportunity to supercharge your retirement savings. Continue to dollar cost average into your index funds or exchange traded funds.
Many studies have shown that if you sell all your stocks and stay on the sidelines when the market eventually rallies, you can drastically underperform when compared to the returns of the S&P 500 Index.
I still remember one advice I got when I started out investing in stocks – accumulating wealth is not about timing the market, but time in the market.
The fact is you never know what the bottom of a stock market correction is until it’s over. Think of market fluctuations as a test for your resolve and your persistence.
Your only concern should be how you can take advantage of the market decline and stop trying to time the market based on the advice of all the so-called experts. If you stay on course and not panic, then you can survive any type of stock market volatility!