A Very Rough Start

| February 2, 2016 | 0 Comments

Over the past few weeks, we have received a stark reminder that investing in the stock market involves risk. From March 2009 through 2015, the S&P 500 has gained over 200 percent, with only a couple of significant hiccups along the way. So what has investors so spooked, and what can those of us with a long-term investment perspective do?

Investors have been rattled with something of a perfect storm of bad news and soft economic readings. A strong dollar has been putting a dent in exports and manufacturing. Falling oil prices have wreaked havoc on energy sector companies and workers. At the same time, cheaper oil typically leads to lower gasoline prices, which has historically allowed consumers to increase spending on other things, but that impact hasn’t been obvious in spending data yet. And increasing doubts about the health of the Chinese economy has led to volatility and unease in other stock markets around the world.

Compounding all of this is the societal tension brought on by Europe’s migrant crisis, and the relatively unpredictable economic and political impacts on those countries.

In short, investors have had a lot on their minds. In a market environment where stocks are not cheap (but not ridiculously overvalued, either), it doesn’t take much to cause something of a stampede as traders rush to place sell orders. The fundamental questions for investors, though, are these:

What’s really happening in the economy? Underlying every investment decision is the health or weakness of the economy. And the U.S. economy is fundamentally sound, if not exciting. Manufacturing may be struggling, but the service economy (which is about 70 percent of the economy) is still quite strong, especially the construction sector. Unemployment (admittedly a lagging indicator) is near all-time lows and interest rates are not indicating trouble ahead. Finally, government spending is on track to increase, adding a significant tailwind. So while we can’t rule it out completely, we don’t appear to be heading into a recession.

Will these overseas events affect us here at home? China purchases relatively little from the U.S., so if their economy is soft, it doesn’t affect us much. A strong dollar makes life hard for companies that have operations overseas, since their earnings in other currencies are reduced as the dollar rises. But it also makes imported goods cheaper for U.S. consumers keeping a lid on inflation. Events in Europe are disruptive, and could impact our trade relationships and alliances in the long-run, but they are also fundamentally unpredictable and those are fairly low probability worst-case outcomes. So on balance, we’re mostly insulated from overseas angst.

So what’s happening to corporate profits? In the end, the price of a company’s stock reflects the value today of all of its future earnings. So if profits are in trouble, then the price of a stock will usually come down. This does seem to be our first hint of an explanation.

Corporate profits have been setting records since 2008, and that can’t go on forever. Workers are pushing hard for higher wages (which really haven’t grown in the past decade) and interest rates are rising, both of which affect profits. And the strong dollar isn’t helping.

What does this mean for the future? The stock market will adjust company stock prices very quickly for new expectations about future profits, and at its core, that seems to be what’s going on recently. It’s not fun to participate in, but it also isn’t a bad thing for long-term investors. If you are investing with funds you don’t need for several years (which should be true if you own stocks), then this most recent downturn will probably represent a temporary correction that will recover in time.

Hang in there. I know it’s not easy advice to hear when the markets are roiled and some pundits are talking collapse and recession. But a recession doesn’t seem likely yet, so this recent downturn (like most) should work itself out eventually. It may take a while and shave a few more points off of the indexes, but for patient investors with long-term goals and a well-thought investment strategy, the recent volatility is just part of investing. What’s more, it may be an opportunity to rebalance a portfolio to pick up some bargains.

This column is prepared by Rick Brooks, CFA®, CFP®. Brooks is Director and Chief Investment Officer with Blankinship & Foster, LLC, a wealth advisory firm specializing in comprehensive financial planning and investment management. Brooks can be reached at (858) 755-5166, or by email at brooks@bfadvisors.com. Brooks and his family live in Mission Hills.

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