Stocks are falling and you want to know why. You’re not alone; we all do.
Our need to explain things is innate. A random walk down Wall Street simply doesn’t suffice. We want something more tangible, something in the news, something non-random.
There is no shortage of explanations for the recent decline. Take your pick: inflation fears, rising rates, a slowdown in China, the “trade war”, tariffs, housing, etc., etc.
For passive consumers of news, any of these rationales will serve their purpose (explaining the why) and are more or less harmless.
But for investors, they can be quite harmful. Why?
Because we are emotional beings and our impulsive response to bad news is to panic and sell after the fact. We respond to good news and higher prices in a similar fashion, by panic buying after the fact (fear of missing out). Needless to say, this is not an effective long-term investment strategy.
The S&P 500 is only down 9.8% from its recent all-time high, just above the average of the 22 prior corrections since March 2009 (-9.3%). All of these corrections had fear-inducing explanations associated with them that seemed like the end of the world at the time. All were soon followed by new stock market highs.
That may or may not be the case this time around. It could be another run-of-the-mill correction or it could be the start of something bigger. We’ll only know in hindsight. Regardless of what happens next, though, reactionary buying and selling is not the answer. If you can’t stomach a 10% decline in stocks, you own way too much in equities. Lower the beta in your portfolio to meet your actual risk tolerance – the point where you can sleep at night.
The reward for being a long-term equity investor does not come without frequent bouts of risk (3-4 corrections >5% per year, on average). During the most peaceful market in history (2017), many investors forgot this lesson. The S&P 500 advanced every single month last year without a drawdown greater than 3%. They are getting a gentle reminder of equity risk in 2018, but it still pales in comparison to what we saw from 2000-02 (51% S&P 500 decline) and 2007-09 (57% S&P 500 decline).
