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Client
Communication Briefing – Market Commentary Five
years of gains in the stock market have finally come to an end. This year is
off to a rough start with losses totaling nearly 10 percent for the S&P
500 through last Friday. As we explained in the fourth quarter market
commentary, a number of factors are driving the sell-off including a slowing
economy, belt tightening by lenders and continuing declines in the real
estate market. Small
companies’ stocks are down even more for the year (over 12 percent) due to
the lack of access to money and limited revenue diversification. As banks tighten
their lending standards, smaller companies that don’t have the assets of
larger multinational companies find it more difficult to obtain loans to finance
their operations. In addition, small companies depend more on domestic
markets to generate their revenue. When those markets are healthy, small
companies do well but when they’re not, small companies don’t have the global
revenue sources to offset weaker domestic sales. Talk of an
economic recession has gained more traction as evidence continues to point to
a dramatic slow down. The stock market leads the economy by six to twelve
months, which means if we are in a recession; it’s already reflected in stock
market prices. Future market declines will come from unforeseen events which
only become apparent after they occur.
The
Federal Reserve and the Administration are taking action. The Federal Reserve by aggressively cutting
interest rates -- an additional rate cut of three quarter percent just
announced this morning along with President Bush’s economic stimulus plan in
the form of immediate tax cuts announced last week. While technically
we are not in a bear market yet (defined as a stock market price decline of
at least 20 percent), we may be getting close. It’s worthwhile to review Financial Service
Group’s strategy to deal with declines in the market. First, we
advise do not give in to emotions and sell out of fear. Unfortunately,
nothing feels better emotionally now than doing what would be the wrong thing
financially. When emotions take over, the undisciplined investor sells at
market lows because it feels good to be out of the market -- following the
herd is more comfortable during times of fear and uncertainty. When stocks start to rise towards new
highs, again the undisciplined investor, not wanting to miss out on further
gains, succumbs to possible greed and buys towards the top of the market.
Both of these emotional responses violate the “buy low, sell high” mantra. By
appeasing short-term emotions, we compromise long-term financial security. Second,
we do not want to get caught in the downward spiral of trying to time the
market of when to buy and sell. Since we cannot predict when the market will
go down nor when it will increase again, the objective is to remain appropriately
invested based on your situation. Over the past 80 years, the average bear
market (based on the S&P 500) lasted less than two years. Occasionally (four times over 80 years) we’ve
experienced a protracted bear market -- declines that continued for
successive years. During those times,
it took an additional three to four years to recover. Over that 80 year
period, stocks averaged returns of more than 10 percent. During the same
period of time, government bonds averaged just over 5 percent. Stocks are already risky enough. Adding market timing increases risk (price volatility)
and requires investors to be right twice, when to sell and when to buy back
in. Third,
for clients who receive income from their portfolio, our strategy is to hold six
to nine years worth of their portfolio distributions outside of the stock
market in cash or bonds. This provides a “safety net” of secure investments to
weather the market declines and wait for the recovery which inevitably
follows the losses. As long as we don’t take risky bets of investing in
individual stocks which can see their value drop to zero due to bankruptcy, a
diversified portfolio will eventually recover. We have many
long-time clients who experienced the last protracted bear market from 2000
to 2002. During that time, we faced
difficult choices and decided not to sell equities. Those clients were
rewarded with five positive years of gains which erased the losses and set
new highs. Inevitably, the market will go down again and now it has. Just as
in the past, we expect a full recovery. Unfortunately, we do not know when
this will come. Our value
proposition to you during times of uncertainty and market turmoil is to be
available for discussion and to remind you of the processes we have in place
to deal with stock market declines. While we may not be able to eliminate your
market fears, our objective is to prevent you from taking action based on
fears that compromise your ability to achieve your long-term goals. We will
continue to keep you apprised of significant market developments. As always,
keep us informed of any changes in your life so we can respond appropriately.
If you have any questions, give us a call. Sincerely, Michael Haubrich, CFP President |
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