After four years of a strong bull market in stocks, we’ve finally experienced our first technical “correction”. Monday’s stock market opened with a heart-stopping one thousand point drop of the Dow Jones Industrial Average. What was the cause and what should investors do in the wake of this stock market chaos?
There appears to be three primary drivers of the market decline:
- China. In August, China devalued its currency which helped shed light on the fact that the growth rate for its economy is slowing more than analysts had anticipated. What it means: China, the second largest economy in the world, remains the fastest growing economy yet at a slowing pace. Slower growth in China is bound to have some economic effect here in America. The government of China does have a number of tools similar to our Federal Reserve that it can use to help re-fuel their economy. While you can expect them to use those tools, you should also expect it could take many months to fully reverse their slowing economic trend.
- Oil. Oil prices have dropped from over $100 per barrel mid-summer last year to below $40 per barrel this week. It’s not so surprising that oil could drop that far…what’s surprising is that it could drop by more than 50% in just a few months. This speed of change causes jolts to segments of our (and the global) economy, particularly certain sectors such as the energy sector. What it means: On the positive side, lower oil prices means lower gas prices at the pump so consumers will effectively get a pay raise which I fully expect them to spend on goods and services. Consumer spending makes up about 70% of our overall economy so that’s a good thing. On the negative side, the energy sector and related companies have seen profits shrink dramatically (along with their stock prices). In the longer run, I suspect the marginal players will be swallowed by the bigger, stronger companies who will further consolidate their dominance.
- Interest rates. The Federal Reserve has indicated that it will likely begin raising interest rates as early as their upcoming September meeting. Rising rates means higher costs of borrowing for businesses across America. Historically, when the Fed changes directions in interest rate policy, it turns into a multi-year trend. Business owners are rightfully concerned with how far interest rates will rise over the next months and years. What it means: I do believe the Fed will raise rates sometime this year but they have indicated they plan to take a ‘measured’ approach to rates. Inflation remains well below historical norms and while our economy continues to improve, the rate of improvement remains anemic. In the face of the current global and domestic economies, it’s hard to imagine rates rising rapidly.
What you should do
It’s important to understand that, historically speaking, the stock market has recovered from market corrections (minus 10% from its peak) and bear markets (minus 20%) one-hundred percent of the time.
Younger investors: If you’re at least ten years away from having to tap your investments, you should view these market dips as an opportunity to buy stocks at lower prices. 401k investors should be happy with market declines since they are automatically ‘dollar-cost-averaging’ into the market with each paycheck. And in many instances, their company is helping with matching contributions!
Older investors: If you’re retired or planning to tap your funds within the next five to ten years, it’s important to have a pot of money in low volatility investments such as money market accounts, CDs and high quality shorter-term bonds. This pot should be large enough to cover a minimum of three to five years’ worth of cash flow (money for bills). For our clients, we’ll typically have a minimum of ten years.
For all investors, be sure you have a process for rebalancing your stock/bond allocations on a periodic basis.
I’m proud to say that during this latest stock market ‘crisis’, with one exception, all of our clients wanted to stay invested or invest more money! Now that’s the kind of intuitive insights that makes a great investor!