1st Quarter 2018 Review

As of December 19th, the Dow Jones Industrial Average and the S&P 500 are on pace for their worst December performance since 1931. They are down 8.3% and 8.1 %, respectively. The Russell 1000 Value, made up of large, dividend paying stocks, is down almost 10% for the month. Jim Cramer, of CNBC, has called this “the most treacherous market” he’s seen since the financial crisis.

While I’m not sure that it is the most “treacherous market” I’ve seen since the financial crisis (we had bigger drops in 2010 and 2011 ), it has been the most challenging to navigate. The market is dropping despite the S&P 500 companies reporting record corporate earnings, record corporate dividends, record corporate share buybacks ($1.1 trillion), a very strong economy, virtually no unemployment, no inflation … The list goes on and on and on. And the markets continue to drop based upon what might happen in the future compared to what is really going on right now.

The Markets Recover Quickly

Understanding how the markets perform is one of the most important parts of investing. The chart below shows the performance of the Dow Jones Industrial Average from 1901 through the third quarter of this year. The Dow Jones has averaged a little better than 9 ½% returns during this time.

Here is what most people don’t know … The Dow Jones has either lost money or recovered from its loss over seventy-five percent of the time. That’s right. 75% of the time the market loses your money, or you are recovering from that loss. Here’s how it works. About 34% of the time the markets lose money (red line in the graph below). An investor would have lost almost 10% per year when the markets are down. A little over 40% of the time the DJIA is recovering from a loss. When the DJIA is recovering from its loses (the green line in the chart below) it produces over 14 ½% return.When making new highs (the black line in the chart below), the DJIA produces less than a 5% return. In other words, if you wait until you feel comfortable about the markets to invest your money, you’ll get the lowest return.

We Are Undervalued

We have referenced this graph many times in the past to measure if the S&P 500 was over or undervalued. This graph is dated as of November 30th, before our December to remember. The S&P 500 is now trading at 14.26 times its forward P/E ratio. This means that the S&P 500 is about a ½ standard deviation undervalued compared to how it has traded over the past 25 years.

Irrational Sentiment

This market has been driven down based upon irrational sentiment. There is no new news that should be driving this market down. What is driving the markets down?

I personally think investors started fearing the unknown and threw in the towel. This is purely a sentiment driven correction. All it takes is a thawing of this fear and the markets could quickly reverse and begin going up again.

Our Patience Has Hurt Us

As we discussed above, all fundamentals point toward a great market. Macroeconomics are very positive for the United States. Our technical indicators were mixed (they just went negative). It was only sentiment that was driving the markets down. Typically, sentiment driven corrections are short lived and shallow. Selling into most sentiment driven corrections typically leads to getting out at exactly the wrong time.

This correction has been extraordinarily difficult to manage risk. There has been no place to hide. Bonds are down for the year. Small-cap is down over 20%. Many areas of the international markets are down 15-20%. Dividend payers are down more than growth companies, very atypical during a correction. Investors have thrown the baby out with the bath water.

What’s Next?

You’ve heard me quote John Maynard Keynes by saying, “The markets can remain irrational longer than you can remain solvent:’ It doesn’t seem like the markets want to hold in here. Investors are being completely irrational. But it doesn’t pay to fight the tape. And as much as I have tried to be patient we are going to get more defensive, ride out this storm, and we will be ready to step back in to take advantage of what should be a quick recovery. We are confident that this will be a short-lived storm and that the ” secular” bull market remains fully intact. We are just going through a short-term bear cycle inside of a secular bull market.

During these times it is more important than ever to remain focused on your goals and not on the short-term performance of your portfolio. This short-term detour is nothing more than that … a little delay in making progress towards your long-term financial goals. We are confident that we can get you there, on time.

This website is solely for informational purposes. Past performance is no guarantee of future returns. Investing involves risk and possible loss of principal capital. No advice may be rendered by Polaris Wealth Advisory Group unless an investment management agreement is in place.