Market off to its worst start ever. What does it mean?…

2016-01-14_1130

…The short answer: Not much.

By now everyone has heard about the recent volatility to start off the new year. While we all wish it weren’t true, the reality is that stocks are called risk assets for a reason, that being that sometimes they go down.

Above average declines can be scary because the markets tend to take the slow and steady route when they rally, and the elevator straight down when they decline. The good news is that this is nothing we haven’t seen before and will likely see again. The above picture shows the maximum declines and maximum gains in the S&P 500 since the 2009 bull market rally began. 5 out of the 7 years we’ve seen decent sized declines, with the average decline of 9.18%. Meanwhile the S&P 500 continued higher, gaining more than 200% during this time, from low to high.

As I type this the S&P 500 is showing a loss of 8.5% for 2016, which is about in line with the average during this current bull market. Sometimes markets trade on emotions rather than fundamentals. And 2016 appears to be no exception. In a prior post, I addressed the potential for those August 2015 lows to be revisited.

Let’s address the issue of China. US exports to China account for less than 1% of US annual GDP. China accounts for only about 7% of revenues for S&P 500 companies. China’s GDP growth output has declined substantially. However China’s economy has doubled in the last 10 years. So even if China’s GDP has contracted by 50%, there is a good chance that the same level of output remains. China does have some serious stability issues to address, and they will eventually figure it out.

Interest rates is more concerning. In a prior post we talked about the short term market reactions to the initial rate increase, and they usually weren’t great. However in almost all cases the markets were higher 12-24 months out. It does appear that  the Fed is a bit disillusioned and perhaps the markets are concerned another 1937 scenario could be playing out.

The more likely scenario is another correction in an ongoing bull market. Recession odds and financial stress index levels are low. However that doesn’t mean we are immune to the 10-20% corrections. In fact history shows that half of all years since 1950, consist of a double digit decline.

2010

In 2010 the market fell 17% from high to low…..

2011

And in 2011 the market fell 21.5%….

So despite all you may read or hear, this is nothing out of the norm. In each scenario the markets were trading higher 12 months out. As investors, there are many things that are simply out of our control. However what we can control is our asset allocation, position sizing and costs. If you have a plan in place, stick with it. If you don’t, now is as great a time as any to put one together.

If you have been shaken up by the recent volatility, perhaps you might have more allocation to equities than you can handle. My favorite rule of thumb is from Buffett himself, he said “you never want to own more stocks in a bull market, than you are comfortable owning in a bear market”. That is a good starting point.

Since we are all programed to have recency bias, everyone still has 2000 and 2008 fresh on their minds. And so every time the market goes down we feel as if this is the big one. The reality is there have been many more examples of corrections that didn’t turn into a market crash. It’s very possible that 2016 will be no exception. Let everyone cry doom and gloom, they are likely the same ones that have called 100 out of the last 2 recessions (think about that for second).

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