In response to the Dow’s drop, the Royal Bank of Scotland says, “sell everything” in the face of a “cataclysmic year”.
We do not want to sugar coat the drop; a drop is a drop. But the truth is drops happen. The most important question to ask and then answer is whether this is the time to abandon your strategy or to reaffirm your strategy.
These are the times which test the commitment to an investment strategy. The Dow has dropped 1,966 points (to 16,346 on 1/8/16) from its last all-time high (18,312 on 5/13/15). It dropped 1,374 of those points in the first trading week of the new year, which has been reported as the “worst initial trading week in history”.
Answering the question during times of market turbulence is never easy, but this time around it is especially difficult – made so by Royal Bank of Scotland’s advice. Such pronouncements have weight and significance because of the firms which make them, but this one is nonetheless wrong. Consider some facts.
Yes, the Dow dropped to 16,346 (perhaps lower after we go to press)
- But the Dow dropped to 16,102 on 8/30/15
- But the Dow dropped to 16,380 on 10/12/14
- But the Dow dropped to 16,361 on 4/20/14
- But the Dow dropped to 15,698 on 1/27/14
- But the Dow dropped to 14,810 on 8/25/13
- But the Dow dropped to 12,588 on 11/12/12
- But the Dow dropped to 12,118 on 5/27/12
Despite these drops, and the doom and gloom pronouncements which accompanied them, the Dow only lost 2.3% in 2015, and it actually gained 7.5% in 2014, 26.5% in 2013 & 7.3% in 2012. The correlation between the Dow “dropping” to the 16,000 range and economic disaster just does not exist.
This is not to say that drops in the Dow, or in the S&P, are never related to economic events. Clearly the economy’s performance is relevant. But at any given time, there is also white noise and irrational emotions at play in the stock markets. The trick is to separate emotions from reality.
Consider the wiser advice of other, more distinguished, economists who deserve every bit of the credibility they have earned.
Burton Malkiel, two-time chairman of Princeton University’s economics department, wrote in the Wall Street Journal, “investors who set modest goals and follow timeless lessons will do fine and be able to sleep at night knowing that their risk is contained. The key to reducing risk is to diversify broadly into stocks, bonds, real estate.”
Jeremy Siegel, senior finance professor at the University of Pennsylvania’s Wharton School, stated, “we will see a Dow of 20,000 in 2016”, hardly a bear’s prediction.
These economists, and other objective analysts who can cut through the emotional distractions, see a very different economy than those who preach the doomsday view.
They see the problems in China but understand that our exports to China represent less than 2% of our GDP. They see the drop in oil prices but understand that for every oil producer whose profit margin shrunk there are many users of oil whose profit margins increased. They see the fed raising interest rates but understand that quantitative easing didn’t boost the economy in the first place, nor will the gradual tapering tank it.
Lastly, they see an economy which grew at about 2% in 2015 along with a 1,356,000 increase in the labor force and a 2.5% increase in average wages. These are not huge successes that signal an economy on a tear, but they are also not harbingers of contraction. The best projections we see for 2016 have economic growth at 2.5% and the Dow gaining. Stocks definitely appear under-valued in reaction to the emotional sell off. Whether they will regain 6% or 8% in the near-term, or the 10% to 15% by which we believe they are undervalued, is not predictable with any degree of accuracy.
We believe equity markets are headed up this year which presents a strong case for remaining in stocks. If stocks fall more, we believe the buying opportunities will be irresistible.
Burton Malkiel hit the nail on the head. A strategy of broad diversification is the best insurance against risk and the surest method to attain your financial goals. If the stock portion of that diversified portfolio becomes under-weighted, then rebalancing into stocks assures the investor that they will reap all the rewards of the inevitable recovery.
We do not know what will happen this year – although we have our belief it will be a positive year. But we know with certainty that several years down the road the Dow will be at 20,000 and today’s dislocations and panics will be history.