Coping With the Frustrating Market

Mr. Market started 2016 on the wrong foot, and his mood has gotten worse throughout this month. Barring a big rebound next week, this will be the third consecutive year the S&P 500 has declined in January—something that has only happened two other times since 1950. The index may also come close to breaking, or even break, the record for the worst January return since at least 1950, based on data from the Stock Trader’s Almanac.

Some of the culprits are identifiable. China’s economy is slowing. Oil prices are slumping. Analysts project fourth-quarter S&P 500 earnings and revenues to be down. Small-cap stocks declined last year and are now in a bear market. Tensions in the Middle East are not showing signs of cooling down. There are other things weighing on sentiment that are harder to blame directly, but they may not be necessarily helping either: the possibility of further rate hikes by the Federal Reserve, turbulence in the junk bond markets and stock valuations that are still not cheap.

Lost among the headlines is the fact that Mr. Market’s tantrums tend to be short-lived in nature. They occur, stocks drop, investors’ nerves become frayed, and then often without much advance notice, Mr. Market returns to being in a good mood. Nothing in the 10.1% historical annualized return of large-cap stocks promises that the ride to building and preserving wealth will be smooth. It’s bumpy, filled with potholes and steep hills. But the road does ascend over the long term. To help you stick with your plan, I have a few suggestions for coping with the currently frustrating market environment.

Realize You Are Not Alone: If you are looking at your portfolio and uttering words not suitable for publication, understand your portfolio is not the only one taking a hit. Last year was a very tough one for stock pickers and so far 2016 has not been any better. As you’ll notice in our 2016 mutual fund guide (which is being sent to the printer this evening), many mutual funds saw their performance lag last year. On the equity side, value was out of favor last year, as were small caps. Even among large-cap stocks, the positive returns were most concentrated among the largest growth stocks. This does not appear to have changed so far this year.

Don’t Give in to the Temptation to Abandon Your Strategy: When returns have investors shouting “Woo Hoo!,” they are likely to stick with the strategy they are following. When returns have them grimacing and yelling “D’oh!,” the temptation to abandon the current investing strategy is strong. Often, the very same investors who are upset with their performance look to see what strategies have worked well in the very recent past and switch to them. This emotional desire to rotate to what’s working right now ignores the fact that short-term results often reflect luck as opposed to skill. Furthermore, over any given period of time, even the best strategies lag. If a strategy has been shown to work over the long term and is based on sound characteristics, don’t stop following it just because the recent returns aren’t good.

Ignore the Forecasts: During periods of uncertainty, it becomes even more tempting to listen to market strategists and prognosticators. The problem is that all of their crystal balls are cracked. Consider the current environment: China’s market and economy is slumping, oil is trading in the $20s, the 10-year Treasury continues to hover around 2% and the Federal Reserve has raised rates just once. If those making forecasts actually have soothsaying abilities, why weren’t they talking about the strong possibility of these events occurring a year ago?

Realize the Big Benefit for Staying Invested: It’s easy to forget, but those who have been maintaining an allocation to stocks have been rewarded fairly recently. Yes, last year was lackluster, but the S&P 500 gained 17.6%, 36.2% and 14.5% during 2012, 2013 and 2014, respectively. Additionally, over the past 10 years, the S&P 500 realized annual double-digit percentage gains six times, even with the very nasty bear market factored in. Simply put, those who have stuck with stocks have been handsomely rewarded. These investors are still holding on to significantly greater wealth even after this month’s market stumble is factored in.

Take a Look at Your Process: Are you approaching investing in a rational, disciplined manner? Are you letting your strategy dictate your decisions as opposed to letting your decisions dictate your approach? When it comes to investing, the only thing you can control is your process; you have no control over what the market does to your portfolio. You can react to the market, but you can’t control whether conditions will be favorable or unfavorable.

Ignore Your Short-Term Performance and Current Portfolio Balance: One great thing about being an individual investor is that you never have to report your performance. It simply doesn’t matter if you were up or down last year (or last quarter) as long as your process is sound. I’ll add that I haven’t looked at my 403(b) account, which is similar to a 401(k) account, since last October. I don’t intend to look at it until late April, when I will then check to see if it needs to be rebalanced.

Those of you who are retired, or otherwise need a certain amount of savings to fund expenses, should allocate your portfolios accordingly. Regardless of the market environment (good or bad), allocate any money needed over the next one to five years to safe assets instead of stocks. While yields on money market accounts, CDs and savings accounts are still very low, you’ll protect the money you need over the short term from stock market fluctuations. Plus, doing so can give you the emotional courage to cope with Mr. Market’s tantrums.

Worth Reading on the AAII Blog

As you have likely heard, singer-songwriter David Bowie recently died. As long-time fans, both my wife and I were sad to hear the news. Bowie was creative in many aspects of life, including finance. In his “From the President” commentary, John Bajkowski discusses how Bowie bonds paved the way for other forms of securitized debt.