Winter Letter To Clients {Part IV}

Here is part IV of our winter letter to clients.  We'll conclude this series tomorrow.

Will Markets Ever Sell-off Again?

The earlier discussion regarding 2018’s market range shows a wider potential price swing this year. This is partly because as markets advance the price range widens due to percentages.  It simply takes more points to move stocks even a percent at higher prices.  What this year’s range also takes into account is the possibility of a much wider market correction in 2018 than we’ve seen in some time.  Stocks haven’t seen a 10% correction since early in 2016.  You have to go back to 2011 by our calculations to find a more substantial decline in stock prices.  Since that last decline in early 2016, the S&P 500 has seen a price advance of 54%.  Yet historically prices decline in any given year somewhere between 10-15% for no reason other than what in retrospect is seen as normal price movement for stocks.  At some point this volatility will return and I worry that some investors are not mentally prepared for that possibility. 

Make no mistake, probability suggests we are in cyclical bull market every bit as powerful and as durable as the rally that lasted from 1982-2000. By that mark then we are about half way through this expansion.  However, even that bull market had periods where it paused to catch its breath and witnessed some pretty spectacular declines.  The most memorable drop was 1987 when prices dropped better than 30%, but there were also better than 10% declines in 1983, 1990, 1994, and 1998.  Most do not remember that the market went nearly four years before meaningfully recovering from the crash of 1987, the principal culprit then being the First Gulf War.  Each of those corrections should be seen in the context of that nearly two-decade bull market and none of these derailed its longer-term advance.  At some point we are likely to see a larger market decline, bouts of heightened volatility and a period longer than a few weeks where prices don’t advance.  Even in this rally, which started in March of 2009, there have been some long periods of time where stock prices in essence went nowhere.

Given how far we’ve come it’s reasonable to ask clients if anything has changed. The easiest way to start is with this exercise:  Open your end of year account statements, or your January statements assuming this rally holds into the end of the month.  Take that account value and lop off 10%.  Assume that is the minimum amount you could see your assets decline at some point in the next 12-18 months.  If your account is worth $200,000 assume it could be worth $180,000.  If it’s worth a million then assume at some point you see at a minimum $900,000.  Remember again, this is what is considered normal in even a bull market!  These may be hard numbers to look at for some if these could cause you to have trouble sleeping at night then we should talk.  I of course do not know when the next decline might occur.  Perhaps it has already started or we may still need to see much more of this advance before prices move lower, just know that it will come just like winter is a season, and then it will likely pass into spring.

**Long ETFs related to the S&P 500 in client and personal accounts.  Short S&P 500 in a personal account as part of a separate individual strategy.