Stock market volatility came roaring back in a big way this week. We saw days where the stock market moved more in an hour than it moved on a weekly basis in the past year. It wasn’t wholly unexpected given the flat stock market volatility we’ve had for such a long time. As an example of these calm investing waters, my portfolio has gone up 16 straights months before this one. That’s a big testament to how good we’ve had it as investors.
The S&P hasn’t had a monthly loss of -1% or more since October 2016. That’s a crazy run of solid returns that had to end eventually. One has to look all the way back to January/February 2016 to find a month like this one. Back then the stock market fell over 5% and my own personal portfolio was down 4.5%. The good part was it rebounded in a big way the month after with my portfolio growing over 11%. Will the same happen here or are we due for a longer correction?
During times like these, it’s important to remember that the stock market is often volatile. Returns won’t always come as easily as they have since 2008. The recent week may seem horrendous but the S&P 500 is only down 4.8% since my last update. 4.8% seems like a lot but it wouldn’t even crack the top 20 of the worst S&P 500 losses in a DAY.
Losses on paper are just that if you’re a long term investor. History has proven that holding tight and buying more in times like these has rewarded investors. We’re still far from what could potentially happen as stocks have historically had a max reduction of 50%. If this month bothered you then know that it’s far from the worst that can happen if you’re fully invested in stocks. Keep that in mind going forward and maybe revisit your asset allocation if 4.8% sends you running towards the sell button.
The truth is that the Schiller PE ratio is still elevated and may give credence to further downward movement if worries about interest rates persist. The plus as I see it is that after years of stalled earnings, earnings growth is emerging again. According to factset, earnings increased 13% from 2012 to 2016. That’s not per year, that’s the total earnings growth for that time period! That’s a terrible rate any way you slice it and is one of the big reasons why the P/E 10 has expanded so much. Stock prices have soared despite earnings staying pretty flat. That changed in 2017. 2017 growth is nearly 11% and 2018 is slated to grow at nearly 19% due to the new tax law.
So why is the stock market dropping now?
Earnings growth is great news for sure but it doesn’t always mean growing stock prices. One of the reasons the stock market has returned so much over the past years are expanding P/Es. Low treasury yields and the lack of alternative investments have mean investors have flooded into the stock market sending valuations through the roof.
Now, we that we see growing earnings, we’re also seeing growing yields. Growing earnings mean a good economy and growing salaries and potentially inflation as well. On top of that, the fed is unwinding their QE program which impacts yields as well.
All that is causing yields to rise and giving investors another place to hold their cash. If yields on treasuries are suddenly more appealing then investors may not be as willing to pay such high P/E ratios for stocks anymore. I talked about this effect in a post before where I argued that low yields meant that the stock market isn’t expensive.
Now that the yield is rising, is the stock market expensive? Growing earnings SHOULD indicate high stock market returns but not if the market P/E shrinks closer to historical norms. P/E expansion has driven the stock market returns of the past few years. It’s possible that the shrinking of the P/E may mute the stock market returns of the future even as earnings grow.
As always, it’s impossible to say where the stock market goes from here. I’m not worried if they go up or down. As I recently on twitter, it may get worse, it may get better, as long as you’re sleeping fine, what’s it matter?
From the perspective of a long term investor, months like this aren’t bad. They allow me to buy securities at a better price and higher yield than I was going to buy them for last month. That’s not a bad deal.
From the perspective of someone who likes to see my portfolio growing every month, months like this aren’t great. I was $500 away from 500k last month and I’m pretty sure I’m even further away this month.
As a reminder, my portfolio was at $499,535 last month. Continue reading “Portfolio Review – February 2018 – Stock market volatility makes a comeback”