Wouldn’t it be nice to turn on the news (or if you are like me, open your web browser) and get some normal, sane, understandable market results for the day?
Instead, yesterday the S&P 500 plunged to an 11-1/2 year low. Both the DOW and NASDAQ closed at their lowest points since March 12, 2003, which was just above the low of the last bear market.
Markets tend to over react at the top and at the bottom. I remember in the late 1990’s thinking, how can this be happening? Technology stocks were so over priced. Their valuations made no sense from a perspective of investment fundamentals. Fast forward to 2008, I find myself thinking the same thing in reverse. Stocks are so undervalued, why are they still plummeting?
When I teach my investment seminars, I say that the stock market, in the short term, is the emotional temperature of the collective. Valuations, P/E ratios, free cash flow and the hundreds of other fundamental measurements of stock prices, do not matter in the short term.
The only thing the market tells us on a daily basis is the whether the collective is optimistic or pessimistic about the future.
What is clear today is that the collective is pessimistic about the future.
In the long run, stocks trend toward the economic fundamentals. Earnings, cash flow and rational measures of value, clearly drive long term stock prices.
The second big truth of the market is that the past is clear. The future is always unpredictable. Timing the market is akin to attempting to determine if your spouse if going to be happy or sad today. Anyone’s guess is a good one and someone is going to be correct.
Barring any near-term recoveries, 2008 is likely to be one of the worst years in history for stocks (domestic and foreign) since the great depression. Unfortunately, other asset classes such as real estate, commodities and even many bonds have done poorly. While it is highly unusual for so many asset classes to fall at once, it is the current reality. Of course, this isn’t news to most of you. The question is how much further until the market hits the bottom and what to do now?
While there are many opinions, no one knows the future. The question for most people is what to do given what has happened and given the uncertainty of the future (especially near term). Much depends on your time frame and emotional constitution.
Previous bear markets have averaged 16 months. We are now 13 months into the current downturn.
The longest recession since WWII has been about 16 months. Assuming this recession started early in the year and it matches or slightly exceeds the longest postwar recession, it might be late spring to late fall 2009 before economic recovery begins. Since a stock market rebound typically precedes economic recovery, the market could rebound before then (historically, it's turned up 60% of the way through a recession). As with all observations, no guarantees are given or implied.
While it would be nice if we were at or near the bottom, there is a possibility that it could get worse. The stock market decline has probably anticipated a significant drop in corporate earnings but when revised earning estimates (likely lower) and actual earnings reports come out over the next month or two there may be further declines. Also, it’s normal for the stock market to overshoot on the downside (as it does on the upside).
It is helpful to look at what seasoned investors are doing. Here is a sampling.
Warren Buffett is buying.
Here are more details: Learn from Warren Buffett
Steve Leuthold, considered a perma-bear is bullish on stocks
Here is more information. Click here for Barron's article
Jeremy Grantham of GMO says, “…the odds are roughly two to one that stock prices will sink to new lows next year.” And he is buying because he does not attempt to time the market in the short term.
Click here for the complete article. Read NY Times, Market Bottom? piece
So what’s this all mean to me?
- Continue to stay out of the emotion of the day.
- Call your advisor (hopefully that is us) to review your needs and your portfolio.
- Look carefully at your personal situation. Is your job secure? Do you have any upcoming major expenses that can be deferred? What is your withdrawal rate from your portfolio?
- Keep the long term view.
As you know, staying power is an critical component to developing an investment strategy. Before anyone should commit money to the stock market, they need to have adequate reserves set aside for emergencies and financial commitments. One's time horizon should really be 5 to 7 years (or even better, the rest of your life).
Has this downturn made you realize you aren’t as risk tolerant as you thought? If so, it is time to change your stock/bond allocation? In general, if you're able to wait (financially and emotionally) we suggest not making any drastic changes now.
What we're doing now:
For retired clients, we will temporarily hold off on further rebalancing. Thus a 50/50 (stocks to bonds) portfolio which may have drifted to a 45/55 or 40/60 due to stock declines will be left as is, effectively making it a little more conservative for now.
For more aggressive clients who remain growth oriented and still have a long-term horizon, rebalancing probably continues to make sense.
For conservative and moderate growth clients, following a discussion of your personal situation, we are tweaking the fixed income investments and getting a little more conservative (giving up some longer term potential benefits in exchange for reduced short-term volatility).
We have looked at every client account for opportunities to harvest unrealized tax losses (losses that can be used to offset any gains or up to $3,000 or ordinary income). We are looking at opportunities to transfer funds from IRAs to Roth IRAs (for clients who have little income or significantly less income than normal this year). We are considering the estate planning opportunity of gifting.
The clients most impacted by this economy and stock market decline are those that are retired.
A prudent withdrawal rate is 3-5% depending on age, etc. One strategy for retirees drawing on their portfolios is to tap those assets that haven't declined significantly first (i.e. draw from money funds, short-term bond funds, longer-term bond funds).
We have run projections for all of our clients taking periodic or sporadic withdrawals to see how long-they could tap fixed income assets before having to sell equities based on the current withdrawal rate. On average, these clients could tap their fixed income investments to cover their monthly withdraws for 3 to 10 years (before having to sell significant portions of their equities in a down market). Of course, this strategy will gradually make the remaining portfolio more aggressive as the fixed income portion is a smaller portion of the portfolio.
If you are withdrawing funds from your portfolio (either periodically or sporadically) consider how the market decline has increased the rate of withdrawal. If you have been taking out more than 3-5% before the market decline, that rate (as a percent of the current value) is now higher. If you've exceeded our recommended withdrawal rate and have been taking out more than 5% (before the recent stock decline), we strongly recommend that you look for ways to cut back on expenses (particularly any discretionary spending). This is not sustainable for a long life expectancy.
If you’re not sure about your withdrawal rate, please call us. For those of you giving money to adult children, carefully weigh the impact on your own finances (if your withdraw rate is too high your money may not last as long as you do). We believe in Mom & Dad first, adult children second, and realize this is a hard pill for many to swallow.
After all this discussion, it is best to prepare for this decline to be longer than the norm and one of the worst markets in our lifetime.
Now more than ever is the time to consider a Prosperity Plan™. I have found no more effective tool to put and keep things in perspective that this. If you have a Prosperity Plan™ and we are managing your portfolio, updates are free! We encourage you to come in and review your goals, investment policy and spending. Whether the news is good or bad, putting it all into perspective for your life is the best way to sleep at night.
I know that market declines take an emotional toll. Please call us at any time. 859-331-7755
For after hours assistance, try one of these options (my current favorite is 7)
If you are obsessive-compulsive, please press 1 repeatedly.
If you are codependent, please ask someone to press 2 for you.
If you have multiple personalities, please press 3, 4, 5, and 6.
If you are paranoid, we know who you are and what you want.
Stay on the line and we will trace your call.
If you are delusional, press 7 and your call will be transferred to the mother ship.
If you're schizophrenic, listen carefully, a small voice will tell you which number to press.
If you are depressive, it doesn't matter which number you press. No one will answer you.
If you are dyslexic, press 6-9, 6-9, 6-9, 6-9.
If you have a short-term memory loss, please try your call again later.
If you have low self-esteem, hang up. All our operators are too busy to talk to you.
If all else fails, chill.
Please forward this blog on to friends, colleagues or anyone who might benefit from it. We welcome new clients who are looking for the kind of disciplined approach we offer.
May prosperity be yours,
Mackey McNeill, CPA/PFS IAR
President and CEO
Mackey Advisors
859-331-7755
Mackey@CultivatingProsperity.com
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