Are You Letting Your Emotions Jeopardize Your Future?

2016 sure started with a bang. In fact, it has been the worst start ever in a calendar year with the S&P 500 down -10% so far as of the end of January. What does the recent market selloff tell us? I believe it tells us markets are made up of emotional, not perfectly rational, people. The fundamentals haven’t changed much in two weeks, but people’s feelings about them have. Fears of a slowdown in China, the negative impact a rising US dollar has on companies selling overseas, and a severe depression in the energy sector (all risks that have been known for some time) have caused increased market jitters. Benjamin Graham, Warren Buffet’s mentor, famously said, “in the short run the market is a voting machine, but in the long run it is a weighing machine”. Said differently, short-term market movements are based on investor psychology and behavior, but fundamentals (i.e. company earnings, valuations, inflation, economic growth, etc.) drive the market in the long-term.

In volatile periods like this it’s always important to revisit personal goals and situations.

Are the declines in the market causing you to lose sleep? If so, there might be a disconnect between your portfolio and your risk tolerance. There are two parts that make up one’s risk tolerance. One is the ability to take risk. For example, if a substantial amount of a portfolio needed to be sold to cover spending goals over the next five years, the ability to take risk is low. The second part is willingness to take risk. How do you feel about portfolio declines and how would you react? If your answer is you couldn’t bear a decline and you would sell immediately, there is a low willingness to take risk. Both parts of risk tolerance need to be paired together to come to an ideal portfolio for an individual. It’s essential to get the match up between risk tolerance and investment portfolio right because the ability to ride out market declines is of utmost importance to investment results and peace of mind.

Let’s take a look at the underlying health of the market and economy.

The stock market and economy tend to follow cycles. From the depths of the last bear market in 2009, the U.S. stock market has recovered everything it lost plus some. Company earnings also passed the prior peak in 2007. Up until recently most of the benefits from the recovery have accrued to companies, via increased profitability, and not as much to the overall economy. It appears that tide has turned with wage gains starting to materialize. It is for this reason the stock market tends to lead the economy. While the economy seems to be in good shape (outside of the energy industry), US company profit margins and earnings have lost momentum delivering roughly 0% earnings growth in 2015. The consensus is that US earnings will grow 6-7% in 2016. We will see if that is achievable, but history shows earnings estimates are almost always too high. So while earnings may not be growing much, I don’t foresee a collapse in earnings like we saw in the bear market of ’07-‘09. My bottom line is, while fundamentals are softening and have been for some time, I don’t see this as a time to panic.

If you have any questions about the current market environment or your specific portfolio, please reach out to your Financial Advisor. Helping investors get through turbulent market environments is a enormous part of our mission.

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