2018 was volatile until the end
It's been a challenging year for many investments around the world. At the moment (as of 12/28/18), the US stock market is down for the year and in "correction" territory (when the market falls 10% or more) since the market peak. The same is true for international markets and for many investment sectors. Some investors and economists are worried about additional market challenges, and even a recession.
How should I react to market conditions?
Investors should react to today’s market climate the way they should react to any market: by holding diversified portfolios and by keeping recent market volatility in perspective. Investing is a process that occurs over a long period of time, across all types of market cycles and environments. Focusing on the long run may require discipline, but investors are often rewarded for not overreacting to short-term news.
Remember all the market’s progress
To better understand this year's market performance, it's important to remind ourselves of how far we've come. We are currently in the 10th year of the bull market cycle and economic expansion. Over this period, the stock market has risen 270%. In other words, $100 invested in March 2009 is now worth about $370 (as of 12/21/18). Those who stayed invested and were patient over the past decade were truly rewarded.
Don’t lose perspective, and remain realistic
The fact that we’re later in the market and economic cycle is why many investors are concerned. But even over the past two years, the stock market is still up over 10%. Last year, there was significant optimism about global growth, which led to higher and higher stock prices. In many ways, investors had expectations that were premature and possibly too lofty.
This year, we're seeing some of those expectations come down to Earth. Issues such as trade negotiations and the behavior of the Federal Reserve have led to investor concern. There were events such as the midterm elections that created uncertainty. Corporate earnings, which had grown rapidly this year, will likely decelerate next year. Interest rates on the US 10-Year Treasury and other long-term Treasury bonds, which had risen swiftly a few months ago, have fallen back as well.
Market drops are followed by recoveries and gains historically
It's important to keep market performance in perspective, especially when the market has been volatile. The chart below shows the S&P 500 US stock market index over different time frames. As you can see, there aren’t many straight or steady lines in sight, but it’s clear that drops are historically followed by recoveries and gains.
Source: Clearnomics, Standard & Poor's
Note: In the chart, the vertical axis shows the S&P 500 price level indexed to 100 at various dates (as represented by the green, blue, and orange lines). Indexing data to a common starting point, such as 100, helps economists make comparisons and see differences over time.
Take the good with the bad
In some ways, the past two years constitute a cycle in terms of global economic growth and investor expectations. Yes, the market is down at the moment, but it should be taken in the context of a market return that was excellent last year. It’s important to take the good with the bad – markets can both overshoot and undershoot. But over the past two years, investors have still experienced healthy returns.
Bull and bear markets are both natural parts of the market cycle, as shown in this chart of the S&P 500 U.S. stock market index over time. Looking beyond the peaks and valleys, you’ll see that there is a clear onward and upward trend over time, which can reward patient, long-term investors.
Source: Clearnomics, Standard & Poor's
How should I plan for in 2019?
As always, it's important to remain balanced by holding a diversified set of assets. After all, the best way to manage volatility isn’t to try to swerve in and out of the market. Instead, it’s to have a portfolio that can handle all the bumps. This type of portfolio provides peace of mind and helps you to sleep better at night.
Reflect on your goals
It’s also a great time of year to reflect on your financial goals, and to make sure your portfolio supports those objectives. If you have decades until retirement, you can more easily look past short-term volatility by holding asset classes like stocks. If your portfolio needs to support spending needs in the short or medium term, you may need assets that are less volatile and perhaps provide more liquidity. In all cases, your portfolio should be aligned with your goals. In some cases, it may be important to seek professional advice to make sure this is the case.
Stay balanced and diversified
While it’s impossible to predict exactly what 2019 will have in store for the markets, it’s clear that staying balanced and diversified is the best way to handle all market environments.