Looking for Answers in the Wake of the Recent Market Correction
The recent drop in the stock market has most people looking for answers. What is going on? Why have stocks dropped so much in such a short amount of time? Market-timers and short-term traders move markets in the course of hours, days, or even months, but we believe the long-term profitability of the companies we own is what drives long-term stock returns. We also know that the kind of movement we are currently experiencing is little more than noise that can safely be ignored. 10% declines in the market on average will happen every year. We have been insulated from this large a decline since the last drop in 2008-2009. There has been a long continuous run up since then with little volatility. In 2017, there were only 8 trading days when the US stock market went up or down by more than 1%. This low volatility and gradual positive gains may have lulled some into unreasonable expectations for stock market performance.
Our message is and has been focused on diversification and discipline. Our portfolios are broadly diversified and not overly exposed to any one segment of the stock or bond market. We are disciplined in our investment management, making sure we didn't pile on as the stock run-up occurred. In fact, our policy of regular rebalancing means that we have been steadily taking profits from the part of the portfolio that has done the best (large-cap US growth and foreign stocks) and re-deploying it where we found more attractive valuations (i.e. small cap and value), and/or rebalancing back into safer investments such as high-quality bonds. This means we have locked in a portion of the 120+% gains of the S&P 500 over the past ten years or so, and now those gains are not entirely exposed to the recent pull-back. It is important to keep short-term drops in perspective. A 5%, 10%, or even a 20% market drop will be a blip on the radar as long as we stay the course.
The next logical question might be whether this is a buying opportunity. Based on current prices, valuations are stretched a bit even after the correction, so it's probably not yet time for big bargain-hunting. However, at current prices, the long-term expected return for stocks are still positive, so we would not hesitate to continue any dollar-cost-averaging, cash deployment, or rebalancing strategies that are already in progress.