Most recently I have had several calls about the recent market decline. As I write this, the S&P 500 is down 8.9% from the high of 6,144 on February 19th and down 4.6% year to date. I'm not surprised by the decline nor the speed. Markets climb slowly and fall quickly. Carson investment research found that since 1928, the market experienced a 3% decline seven times a year and almost four times a year, a five percent correction. This is nothing new.
The chart above shows the S&P 500 performance returns, represented by the gray bar and the furthest the market fell on an intra-year basis (peak to trough) by the red dot. An investor's chances of earning a positive return have been pretty good with the market going up in 34 of the last 45 years. However, markets do not go straight up. 100% of the last forty-five years, the market has experienced a negative period from peak to bottom at some point in the year. That is the hard thing for most investors to stomach. We just don't like the down times. The bottom line: If you invest in the market, you are going to experience volatility and some degree of downward movement.
The real question is, "Is this temporary or something longer term?" The Covid market correction in 2020 lasted 0.1 years and resulted in a 33.9% decline from peak to trough. The 2022 bear market lasted 0.7 years and resulted in a 25.4% decline. They were so short, most people didn't notice. However, a little longer bear market like the Y2K decline in 2000 which lasted 1.5 years and resulted in 36.8% decline, followed quickly by the sell off as a result of the 9/11 tragedy, resulting in an additional 33.8% decline; felt like an eternity of negative returns for investors.
Before I discuss my opinions on the reason behind this fall, ask yourself one question: "Am I a long-term investor or a short-term speculator?" This is important because long term investors use "time in the market" rather than "timing the market" which is what speculators do. If you are a long-term investor, you should not be worried about 5% declines or even bear markets because you are looking ten years into the future. If you are a speculator, you may want to be concerned with the near term after reading this.
In my opinion, this is the reason for the recent decline:
DOGE: Elon Musk and Donald Trump are doing two things that are affecting the market. Whether you think they are good or bad is not of concern. We are talking about money, not politics. Simply put, they are cutting government spending, literally with a chainsaw AND imposing tariffs on foreign governments like Canada, Mexico and China.
Cutting government waste and fraud is a good thing. However, it will raise unemployment but most importantly it will remove capital from the private sector. The tariffs are being used for multiple reasons: first as a negotiating tool with our neighbors on helping us to tighten the borders. This is mainly to fight illegal drugs and crime from entering the country. Tariffs are also used to either balance our trade with other nations OR to raise capital to pay debt. One is going to happen one way or the other. However, as countries impose their own tariffs on the goods we export to them, more than likely their citizens will buy less which will in turn hurt U.S. companies, earnings could fall and jobs could be lost.
RECESSION FEARS: Everything that I just explained COULD lead to a recession and if that happens, we could see real estate decline substantially on the residential and retail side. This could spill into the banking sector as it did in 2008. 2008 was a perfect bubble of both a maxed-out buyer that was speculating combined with investment banks that were leveraging the loans and rating agencies that mis-graded them. I do not think that we have those problems today.
The market does not like uncertainty and right now there are many reasons to be concerned.
WAR: The February 27th blow up in the Oval Office that ended with President Trump asking President Zelensky to leave the White House shook world confidence in a peace deal between Russia and Ukraine. Europeans are now concerned with their own safety and the future of NATO. This was just another piece of wood on an already raging fire.
NVDIA: Last month I spoke of the strange January we experienced which brought into question the true need of NVDIA's new generation of chips to run open AI. Many of the details of the story have seemingly been debunked. However, it started the sell off of one of the "Magnificent Seven" which has spilled over to the others. Keep in mind, the S&P 500 is a weighted index, which means it does not represent an equal share in the other 493 companies in the index. Over 40% of the S&P 500 was made up of these seven companies until recently. This concentration risk in the overall market has added to the intensity of the sell off.
VALUATION: This is, in my opinion, why we are seeing the sell off. When a rubber band is stretched to far, it pops. When a pipe has too much pressure, it bursts. When a bubble gets too big, it pops. The market is the same. When valuations, as measured by the price to earnings ratio, get too pricey, any little thing can trigger a sell off. We have seen many little things, that when all combined with an expensive market, have created a market sell off. The chart below displays the 30-year average PE ratio for the S&P 500. As of January 31st, the market was trading at almost 22 times earnings with a thirty-year average around 17. That is approximately 30% higher than the average. The PE ratio is not a guaranteed predictor of a market fall. The PE ratio can stay high for a long time. But when the companies of the S&P 500 earnings slow or even decline, historically speaking, the market is soon to follow.
Again, the question is, "Is this a short-term pullback or the beginning of a bear market?". IF we see earnings begin to slow due to the geo-political events, tariffs, cutbacks, etc... then we may be in for a longer pull back than normal. On the flip side, Canada and Mexico may hurt more than we do and the tariffs could be over tomorrow. The cuts in government spending could impact our deficit and be returned to the taxpayers in the form of lower taxes replacing the capital that was being wastefully spent by our government. Lastly, the peace deal could be worked out sooner than later and poof… markets are back up. No one can know for sure. That is the risk we take.
In my managed accounts, we began raising cash last summer and have sat on the sides for the most part earning a decent money market rate while we wait. Legendary investor Warren Buffet has done the same, holding more cash in Berkshire Hathaway than he ever has. Here is an interesting article on Buffet's cash and the PE ratio: https://www.investopedia.com/why-warren-buffett-is-holding-usd325-billion-8772306.
If you are a long-term investor, it makes sense to review your holdings for losers that you can live without and consider selling to have cash ready should the market go on sale. If you are a retiree, I suggest you manage your allocation. You should never have all of your retirement assets in equities during or close to retirement. And if you answered the question by saying, "I'm a speculator." I suggest you put your seat belt on and enjoy the ride. Like a roller coaster, it's going to be a little scary.
If you would like our assistance in any way or to just have a cup of coffee and talk about the markets, please give the office a call to set an appointment. 731-285-0097
Until next time, Cheers!
Source: FTportfolios.com 2024
Yardeni.com 2024
JP Morgan, guide to the markets January 2025
investopedia.com