Even after delivering strong gains on Friday, the S&P 500 Index and the Dow Jones Industrial Average are both down roughly 2% from their recent record highs. In general terms, a 2% market decline is somewhat commonplace, meaning it is nothing to worry about. However, the current bull market has now lasted for about 66 months, making it the fourth longest in history. As a result, it is relatively easy to find stories speaking of how a correction (10% decline), or, even worse, a bear market (20% drop) is imminent. The clamor about impending doom grows even louder every time the major market averages start to move lower (as both the Dow and S&P have done for much of the last two weeks). It is also worth noting that on Monday, October 6, it will have been 1,100 days (or just more than three years) since the market’s last correction.
Market Correction/ Bear Market
We do not profess to know when the next correction or bear market will take place. We do think that investors should expect more market volatility than we have seen for much of the last year. As we discussed a couple of weeks ago many members of the small-cap Russell 2000 Index have fallen more than 20% – the Russell 2000 closed 10% below its previous high on October 1. The S&P 500 is not immune to such trends either. We note that only about one-third of that index’s members moved higher in the third quarter. It is at least possible that we are in what could be called a rolling stock market correction or bear market. In other words, when small-cap stocks start to deliver stronger performance, large-caps may lag.
Domestic and Foreign Economy
In the US, the environment still looks somewhat favorable for stocks. The economic data remains positive and the Federal Reserve’s monetary policy remains accommodative. However, quantitative easing is expected to end, and the market is starting to think more carefully about when interest rates will start to move higher. This should add to the market’s volatility.
Outside the US, we see some reasons to be concerned: Europe’s economy is underperforming, Japan continues to try to extricate itself from its long-standing malaise, and economic growth in China is slowing.
Given our more positive long-term view about the market, we do not currently see cause for concern. There are a number of reasons for our view:
- We are long-term investors (we look for stocks that we can hold for three-to-five years or longer);
- Many of the stocks held in client portfolios are in taxable accounts (so we favor selling when a better opportunity has been identified);
- We have no way of knowing for sure what the market will do;
- We are not market timers;
- Even if the market falls, we believe it will ultimately recover; and
- We believe our diversified portfolios remain the best investment approach.
BWFA Investment Approach
In this environment, we continue to look for attractively valued securities that will benefit client portfolios. In particular, we are interested in stocks that have underperformed the market over the last year. If the underlying business fundamentals of such companies remain intact, such securities can benefit the long-term returns of client portfolios.