Wow! What a crazy December it has been in the stock market! In fact, it’s been a pretty crazy year. So far, 2018 has seen both the biggest single-day decline and biggest single-day gain in the Dow Jones Industrial Average in history. (Source: Dow Jones)
Investment professionals generally define a market correction as a 10% or more loss in the market indices. The correction becomes a bear market when the decline reaches 20%. During the month of December 2018 alone, the Dow Jones Industrial Average (DJIA) has declined by 15% at points, though it has recovered some of that decline. (Source: Dow Jones)
The truth is that the stock market averages one decline of 14% annually, and daily declines of 2% or more happen 5 times per year on average. Earlier this year, market broke its record for the most consecutive trading days without a 5% or more decline, a streak of over 400 days. (Source: Dow Jones) While the volatility we’ve experienced this month is not normal, either is the calm the market experienced last year.
By many measures, the economy remains strong. A fundamentally strong economy supports corporate earnings, and earning are what ultimately drive the stock market. However, at the moment, several issues are dampening investor sentiment such as uncertainty surrounding trade policy, lower oil prices, rising interest rates, the government shutdown and other geopolitical concerns. Government policy has played a large role in 2018, including the fiscal stimulus provided by the tax cuts. Reduced regulation and increased government spending have also helped to spur growth. Perhaps the most important government policy effecting the markets has been the Federal Reserve’s decision to continue to raise interest rates. The Fed’s goal of returning rates to more normal levels has weighed on stocks and has drawn the ire of President Trump. However, factors like high employment, high consumer spending, an improved business environment, and tame inflation may combine to create a favorable investing environment, supporting both growth in the economy and growth in corporate profits. (Source: LPL Financial Research)
Investor sentiment and the herd mentality can move stock prices in the short-run. However, take a minute to remember what shares of stock, and the market overall, represent: ownership in real businesses. When a company issues stock, it is selling a percentage of ownership. Today, most publicly traded companies issue millions, or even billions, of shares of stock, so each share represents a very small percentage of ownership. To understand the concept, consider a business with two owners, each holding 50% of the company. Obviously, each owner would have a say in how the company is managed, and they would split the profits between them. Publicly traded stocks work the same way, except the owners number in the thousands, and the percentage owned is tiny. While the value of stock changes second by second, minute by minute and day by day based on what someone else is willing to pay for it, ultimately the value of the stock is the value share of future profits.
Drops in the market are not an enjoyable experience. Unfortunately, it is a normal part of investing, and can occur in healthy markets. The uninterrupted climb of the market over that last year and a half has distracted many from that fact. Emotion is the enemy of investment success, and times like this underscore the need to have an overall financial plan, including a plan of how to invest your assets. A plan may help to keep emotions out of the investment process. Assets committed to the stock market should be longer-term assets – money you won’t need to access for at least a few years. Maintaining a long-term perspective and focusing on the underlying fundamentals of the economy and the market may be a useful approach.
For more information, you can listen to the podcast of Smart Money Management radio show on this topic, along with others, at www.alderferbergen.com.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.
All performance referenced is historical and is no guarantee of future results.
Economic forecasts set forth may not develop as predicted.
There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.
Asset allocation does not ensure a profit or protect against loss
All investing involves risk including loss of principal. No strategy assures success or protects against loss. All indices are unmanaged and may not be invested into directly.
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