4 Things You Need to Know About Investing in 2016
We’ve seen a lot of headlines recently, most of them pretty alarming to the average person. Hand in hand with those headlines we’ve seen markets make some of the most substantial short term moves in recent history. In the first 5 market days of 2016 the S&P 500 dropped nearly 6%, the biggest 1 week drop we’ve seen since August 2011 (when the S&P dropped about 11% in 5 days).
The deluge of negative news stories and depressing angles on the global economy and the stock market can be overwhelming and really create the idea that some kind of action has to be taken or something terrible will happen.
Reality, at least at this point, is more than a little bit different.
There are four crucial things serious investors need to understand about the market we face in 2016:
1) The Federal Reserve is less able to suppress market volatility in the short term as they guide to higher interest rates.
2) Market volatility is likely to return to pre-QE levels.
3) Short term market swings in both directions will be larger and occur faster as a result.
4) Bear markets are almost always accompanied by recessions.
#1 answers the “why” of what we are seeing, and #2 and #3 describe the immediate result of #1. #4 is the reason successful investors aren’t going to let the first 3 drive them to take actions that are likely to hurt their investment goals.
As you may have surmised, investors that exited the market in 2011 due to fear missed out on a substantial move up in the market, and a lot more money in their investment accounts.
This is like running out of a building when the lights go on and off for a couple minutes because you are afraid you might die in a fire. Most of the time, lights going on and off don’t mean the building is on fire. Most of the time, smoke means a building is on fire.
Right now, the lights are flickering in the market, but there isn’t any smoke to indicate a recession.
So, how do the most successful investors deal with flickering lights?
According to a recent LPL behavioral finance paper on 5 Common Investor Mistakes, the top 3 things successful investors do differently are 1) They do not react to easily available information (read that as media headlines and the underlying stories, i.e. incomplete information), 2) They basically completely ignore short term performance (including the deluge of messages about short term events in financial markets) and 3) They follow their investment plan, not the herd.
What’s really interesting is that the less successful an investor you are, the more likely you are to act on incomplete information (i.e. headlines and media articles, short term falls in stock prices).
Wealthy, successful investors beat the average investor by a measurable margin year in and year out. They are less likely to panic sell and they maintain long term perspective. That doesn’t mean they buy and hold no matter what, but they are not affected by short term market noise and rarely trade assets for cash except in the face of looming recessionary bear markets and the high probability of serious losses.
Why is that?
The graphic study below was put together by JP Morgan (Bear Markets and Bull Runs). For those that don’t like these graphs and data tables, I’ll put it together for you;
Of the 10 bear markets we’ve seen since 1929;
* 8 included a recession
* 4 saw spikes in commodity prices
* 4 featured an overly aggressive Federal Reserve (2 of those came with recessions)
* 5 had extreme valuation bubbles (3 of which also had a recession)
So, it’s clear the common denominator of bear markets is recession. Only 2 bear markets occurred without a recession, and they were shorter and shallower than the others.
Bear markets that don’t include recessions last an average of 5 months and drop 30% less. They generally don’t result in catastrophic damage to investment portfolios.
So, where are we now?
* There is no recession currently on the horizon
* 1 rate raise in 6 years does not yet make an overly aggressive Fed
* Commodities are crashing
* While valuations are high in some areas they are not in bubble territory in comparison with the past.
So, until one of these situations experiences a material change, the most successful investors will continue to prosper by sticking to their investment plans.
Yes, the lights appear to be flickering. But it pays to wait for smoke before deciding the building is on fire.
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To Smarter Investing,
Chief Market Strategist
ACI Wealth Advisors, LLc
Process Portfolios, LLC.