The Dow Jones Industrial Average finished down 237.85 points or 1.14% yesterday. This is no big deal. In fact, the market has declined 5% or more every 5 months on average since 1946*. That's 183 times. Dare I say it's normal. Here's an excerpt from an excellent article that appeared at Bloomberg.com, written by Charles Lieberman about the media's nearly constant shouting at us about the doom and gloom to come.
Volatility has declined very sharply, so quite naturally, pundits suggest that investors are complacent and conditions are ripe for a nasty surprise. Such warnings deserve harsh criticism.
First, volatility should be down, given the performance of the economy and markets. Second, focusing on volatility encourages short-term thinking, which is extremely harmful to investors trying to achieve their long term goals. Third, it is entirely useless to warn against a potential market decline when the warning is provided without any kind of time framework.
High volatility is a normally occurring, yet unpredictable, event, at least insofar as timing is concerned. Market declines of 10 percent occur almost annually, and even multiple times within a calendar year. This is simply within the normal range of historical volatility. Yet when it happens, some pundits go wild, suggesting the drop is just the first leg down of a much larger decline. In fact, several such declines have occurred since March 2009, yet the market has risen more than 200 percent off that low. When the decline proves to be temporary, such negative market commentary disappears temporarily, waiting for the next opportunity to warn of another bout of market volatility. Or, they forecast that the decline in volatility demonstrates that investors have become complacent and vulnerable.
Why shouldn't the markets be complacent right now? Economic growth has been on an incredibly consistent, yet moderate 2 percent trajectory for some years. Unemployment is less than 5 percent, down from 10 percent in 2009. Corporate profits are rising again, after faltering due to a large slowdown in the oil patch following the big drop in crude prices. That took inflation close to zero, which some pundits suggested would start a problematic bout of deflation. Instead, it proved to be just a temporary interlude before prices converged to the higher "core", which declined only slightly. Now, both are reverting to 2 percent, which has enabled the Fed to start gradually normalizing interest rates.
I would care little about these Chicken Littles and their desire to instill fear in the hearts of investors for their purposes, except that they inflict enormous harm on individual investors. How often do retail investors read such warnings and decide that to be safe, they should reduce their exposure to the market? Some pull out entirely. It happens far too frequently. I know of one individual, a close friend of a client, who converted his entire portfolio into cash late in 2008 and has been unable to bring himself to buy back in to this very day! For years now, he thinks he's missed the recovery, because he's read warnings that stock prices are high and vulnerable.
I'm back. I said above that a 5% decline happens about twice a year on average. It was off 1% yesterday. I don't know how often that happens, but obviously much more often than twice a year. If it's normal to have a 5% or more decline a couple times a year then it stands to reason that it's also normal to have a 1%-plus decline several times a year, on average. But no one has told the media. They must not realize how normal it is. Look at some of the headlines after the market close.
Not only do they not realize how normal it is, they insist on tying a reason, or multiple reasons or causes to the market's pullback – or as one headline put it "came to a screeching halt." One article stated "The catalyst for Tuesday's slump wasn't definitive." How about, sometimes the market just goes down. However, that same article went on to say "some market participants attributed the slump in equities to fears that Trump's legislative agenda as it pertains to Wall Street would face delays as the GOP-led health-care overhaul plans appeared set to struggle on congress". And "Perhaps factoring in the decline for financials was a slide in Treasurys..." You can see it in the headline above, "Trump honeymoon over: Markets are now scared his policy promises won't come true."
The truth is that the events of the day and the fact that the market was down are independent of one another, for the most part. I mean, sure, there are factors that can drive the market down but no one can pinpoint the timing of those factors or the degree to which they impact the market. Just look at the election as an example. Everyone and their brother said that if Trump was elected the market would hate it. All of the so-called experts couldn't have been more wrong. I feel sorry for the people that made any investment decisions based on those predictions! The Dow is up over 12% and more than 2,300 points since the election.
If they keep predicting bad things long enough they will eventually be right. As Paul Samuelson is famous for saying, "Wall Street indices predicted nine out of the last five recessions."
Ignore the headlines. It's just noise. Focus on the long term. (this is a 10 year chart)
Not the short term. (this is a one day chart)
And for crying out loud keep a positive outlook and attitude. With that in mind, I'll leave you with this from Barry Ritholtz - "The data strongly suggest that very good years in the U.S. stock market are followed by more good years."
* American Funds - Long-Term Investors Can Weather Market Declines
Headlines from of CNBC, CNN, MSN.
Charts: From YahooFinance.com showing Dow Jones Industrial Average
All indices are unmanaged and investors cannot actually invest directly into an index. Unlike investments, indices do not incur management fees, charges, or expenses. Past performance does not guarantee future results. Certain sections of this commentary contain forward-looking statements that are based on our reasonable expectations, estimates, projections, and assumptions. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. Dow: A price-weighted average of 30 actively traded blue-chip stocks, primarily industrials including stocks that trade on the New York Stock Exchange.