Selloffs – These Things Happen and It’s Okay

By David B. Armstrong, CFA | Feb 13, 2018 | Invest My Wealth, Weekly Market Commentary

I know that it’s never comfortable seeing account values decline. No one likes to lose money and no one likes the way it feels when everyone is talking about the recent selloff.

The most important thing that any investor can take away from last week is the need to reflect on your core beliefs, goals and the current fundamentals of the market. The stock market is not the Craps table in a casino…it is a collection of real companies with management teams and goals, and employees working every day to drive sales, create earnings and cash flow, and manage assets on their balance sheets.

As I have written about before, earnings are important. A stock’s price is a function of its company’s future earnings. Yes, interest rates always play a role in things, so any fear of higher interest rates is understandable, BUT not in the way we have recently seen. Interest rate news is not a cause of overnight market volatility. It is true that as our economy sees interest rates rise, it will not act as any sort of tailwind to equity prices or future earnings. Higher interest rates should be expected and are certainly already forecasted over time.

I just think that in the push and pull between interest rates and earnings, earnings are currently set up to win.

Monument’s opinion is that the stock market still has considerable upside left for the next 12 to 18 to 24 months, and that window is reasonable for investors who already have a plan in place that includes an allocation to short-term cash.

The Straightforward Investing Equation

The equation is straight forward – think of two containers.

The first container should have cash that you may need over the next 18 months.

The second container should be your “at risk” portfolio. It should not include any money you will need in the next 18 months…That’s what the first container of cash is for. It should have an asset allocation built to grow over time at a rate of return that will outpace inflation. It should also include some “safe” investments for cash that may be needed shortly after the 18 months.

The good news is, a lot of these market corrections will sort themselves out within the 18-month timeframe. This means, if you go by the container guidelines above, you should not have to sell stocks after a correction because you need cash – that would be poor planning.

In a panic environment like last week, where it seems like everything is going down, the news breeds confusion and people run for the door to sell. The first cash container will keep the true investor from getting sucked into the mania.

Finally, an important component of this equation is to never be leveraged in the equity market. It’s not necessary. Yes, there are certain situations it’s okay to borrow against a portfolio, but it’s usually for short-term purposes, like to avoid triggering tax bills for short-term cash needs.

Selloff environments like the past week give us at Monument a chance to step back and assess where we are and what we believe. We concluded that this is a correction and that the specter of recession is not evident. Recessions cause bear markets. This is not a bear market.

So What Exactly Was Going On Last Week?

In what seemed like 12.5 seconds, we saw extreme enthusiasm turn into extreme negativity.

Typically, when you see a big selloff there is some type of trigger that gets it going.

Not this time, and that’s what has most folks scratching their heads – there simply was not any one big incident that shocked investors. There hasn’t been any softness in earnings or economic data…but cause for the market correction has been attached to anxieties over increasing inflation, a fear that the Fed will raise rates faster than expected, and dissolution of a short volatility Exchange Traded Note that lost basically all its value.

Rising interest rates are definitely a big picture concern. However, no one I know would have said on January 26th that they were worried about higher interest rates causing a market pullback.

Here’s what I think…The Constantly Negative Business Channel (CNBC) hypes up the economic data knowing that selling fear is second in profitability only to selling sex. So far, I think this correction has been a healthy unwinding of the hyperbolic gains from late 2017 through January, 2018.

It’s a reality check (also known as Mean Reversion) for investors who had become too optimistic. Let’s call it the point where the FOMO (Fear Of Missing Out) buyers quickly became the LIFO (Last In First Out) sellers.

So Why Does Monument Still Have a Positive Outlook?

As long as earnings and economic data remain strong, the market will work through this selloff and any future corrections. Sooner or later, it will rise higher again.

Regrettably, big market corrections can sway sentiment levels, which can impact the economy. If the decline gets worse, there will be more of an impact on future economic data…the reverse of the wealth effect.

Corporate Earnings

Corporate earnings are the best they’ve been in years and company management teams are maintaining a conservative bias. We believe that earnings will extend the recovery/bull market as long as the Fed stays one step behind. In my blog last week, I wrote that we believe they will.

“Yes, the Fed will continue to raise rates, but it will go slowly to allow the U.S economy to maintain acceleration…the President would not have nominated the new Fed Chairman if his plans were to do anything differently.”

So yes, rates will keep moving higher. We believe the yield curve will steepen, but inflation will stay contained. Global competition and technology advancements will act to reduce costs, increase productivity and spur innovation across the board.

To Conclude

Look at last week as a fire drill. Did it make you panic or create anxiety? Then you may not have the tolerance for risk that you thought. The easy antidote for that is to raise some more cash. Did last week make you realize that wish you did have about 18 months of cash? Well markets are at November levels, and that’s not bad. It’s okay to raise cash in a market 10% off the peak.

If you are an investor who is looking for some help with your financial planning or portfolio management, let us know. You can email our Team at info@monumentwm.com and we will set up a time to talk.

Keep looking forward,

Dave

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