“We don't know. We simply have no idea."

That was our response to a financial media reporter when he recently asked us about which way the U.S. equity market was headed after the very difficult start to the New Year (global equity markets are all down meaningfully since December 31st). Unfortunately, that response probably does not make great copy and will not be published, but it is the truth. To say anything else would be disingenuous and, frankly, meaningless.

That is always our response when asked about surmising the future short-term direction of the market (see our past comments made during volatile market periods in August 2015 On Recent Market Volatility & Bringing Back the 90's and October 2014 On Recent Market Volatility).

The slighter longer, more eloquent answer goes something like this:   

 

"We, along with everyone else in the world, cannot accurately or consistently guess the direction the market will move next this time around — it could be up, down or sideways. We simply do not know, and we do not have a crystal ball. One thing we know for certain is that emotion and fear have returned in the markets, and when that happens capital markets usually become divorced from their underlying financial fundamentals."

 

No one (especially clients!) want to hear this answer when markets are stressed because it does not necessarily exude confidence and assure them everything will be all right.

But it is the truth. We just don't know.

Here is what we do know:

1.     Financial markets are cyclical. Despite the shockingly long period of complacency (or the lack of very significant equity market sell-offs) since 2009, equity markets have a tendency to correct (go down) by over 10% (peak to trough) in about 50% of any annual period. This has been the case since 1950 using the S&P 500 Index as a proxy. As a reminder, we have had a few 10% corrections since 2009 and low and behold we survived! Similarly, we will survive this one.

2.     "Bear" markets, technically defined as a 20% correction, happen and can happen again. According to Fundstrat Global's Chief Market Strategist, Tom Lee, since 1962 there were 44 previous declines of 10% or more, and 19 of those corrections became bear markets. Will this one turn into a bear market? We don't know. But it can happen at some point in the future. Steel yourself now.

3.     In the grand scheme of things, the short-term volatility we experience from time to time is nothing more than a blip. Given a long-term investment horizon, an investor may not remember these bouts of market turbulence 10, 20 or 30 years from now. We can almost guarantee it.

4.     Reacting emotionally to the downside volatility and not sticking to your financial plan in the short-term can be a long-term mistake. A decision to sell during times like these can make the pain, anxiety and sleepless nights go away, but so can drinking a lot of bourbon. Both work in the short-term but both can also cause problems in the long-term and are probably not a great idea. By selling, you realize a permanent loss of capital immediately and forgo the inevitable move higher. After all, eventually, over a long enough period of time, financial markets may move higher.

5.     Because human beings are involved in financial markets and human beings are controlled by the still-primitive "fight-or-flight" behavioral response when faced with stressful situations, financial markets can forever oscillate between complacency and insanity. Howard Marks, legendary investor and author of one of our all-time favorite investing books The Most Important Thing: Uncommon Sense for the Thoughtful Investor, says it best:

"The bottom line is that investor psychology rarely gives equal weight to both favorable and unfavorable developments. Likewise, investors’ interpretation of events is usually biased by their emotional reaction to whatever is going on at the moment. Most developments have both helpful and harmful aspects. But investors generally obsess about one or the other rather than consider both...It all seems so obvious: investors rarely maintain objective, rational, neutral and stable positions. First they exhibit high levels of optimism, greed, risk tolerance and credulousness, and their resulting behavior causes asset prices to rise, potential returns to fall and risk to increase. But then, for some reason – perhaps the arrival of a tipping point – they switch to pessimism, fear, risk aversion and skepticism, and this causes asset prices to fall, prospective returns to rise and risk to decrease. Notably, each group of phenomena tends to happen in unison, and the swing from one to the other often goes far beyond what reason might call for.

In Marks' words, clearly the investor psychology and emotional reaction to the events at hand have become very pessimistic, fearful, risk averse and skeptical all at once since the beginning of the year. Why you ask? Again, we don't know!

But we do have some ideas.

We laid out one idea in December last year in our post On Stars Wars & the Fed's Gambit. Today's market consternation comes from the anxiety of the Federal Reserve Bank's first increase in short-term interest rates in almost 10 years, ending a remarkable period in U.S. monetary policy history that kept the rate at 0% for exactly seven years after the financial crisis.

Another idea is the angst associated with the state of declining global-economic growth and the continued negative impact on growth mostly from slowing Chinese and U.S. economies after seven solid years of growth. The unprecedented nature of the past seven years raises questions about what might happen in the future due to the impact of these two drivers, as they could derail the fragile business cycle expansion we are experiencing today.

While we don't know when the market will stop going down, and we have some ideas why it is going down, our noble search for investment truth will continue! Perhaps when the reporter called us we should have been quicker on our feet by channeling Abraham Lincoln in the conclusion to his 1859 speech before the Wisconsin State Agricultural Society:

"It is said an Eastern monarch once charged his wise men to invent him a sentence, to be ever in view, and which should be true and appropriate in all times and situations. They presented him the words: "And this, too, shall pass." How much it expresses! How chastening in the hour of pride! -- how consoling in the depths of affliction!"

Yes, this too shall pass!

 

 

DATA SOURCE: BLOOMBERG

This material is for informational purposes only and is not intended to serve as a substitute for personalized investment advice or as a recommendation or solicitation of any particular security, strategy or investment product.  The opinions expressed do not necessarily reflect those of author and are subject to change without notice. Past performance is not indicative of future results. Reference to an index does not imply that a portfolio will achieve return, volatility, or other results similar to an index. Performance of an index is not illustrative of any account, portfolio or strategy managed by Sequoia Financial Group. It is not possible to invest directly in an index.

The views expressed represent the opinion of Sequoia Financial Group. The views are subject to change and are not intended as a forecast or guarantee of future results. This material is for informational purposes only. It does not constitute investment advice and is not intended as an endorsement of any specific investment. Stated information is derived from proprietary and nonproprietary sources that have not been independently verified for accuracy or completeness. While Sequoia believes the information to be accurate and reliable, we do not claim or have responsibility for its completeness, accuracy, or reliability. Statements of future expectations, estimates, projections, and other forward-looking statements are based on available information and Sequoia’s view as of the time of these statements. Accordingly, such statements are inherently speculative as they are based on assumptions that may involve known and unknown risks and uncertainties. Actual results, performance or events may differ materially from those expressed or implied in such statements. Investing in equity securities involves risks, including the potential loss of principal. While equities may offer the potential for greater long-term growth than most debt securities, they generally have higher volatility. Past performance is not an indication of future results. Investment advisory services offered through Sequoia Financial Advisors, LLC, an SEC Registered Investment Advisor. Registration as an investment advisor does not imply a certain level of skill or training.

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Investment advisory services offered through Sequoia Financial Advisors, LLC, an SEC Registered Investment Advisor. Registration as an investment advisor does not imply a certain level of skill or training.

On Market Declines & Knowing What You Do Not Know | Sequoia Financial Group

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