“I love a good correction. It weeds out the weaker investors” A former coworker of mine used to say that when markets were volatile. It’s a great line, and I’ve used it more than twice. It is true statement. Average investors drastically underperform markets, and many of those average/weaker investors underperform because they scared off by volatility.
Since we aren’t average investors, we embrace volatility. We as astute investors see volatility as evidence that stocks will continue to perform much as they have the last ~100 years, i.e. be a superior long-term asset class combining the best combination of ROI (return on investment) and liquidity, while at the same time being wildly volatile over short-term periods.
Looking at our above and below charts we can see that stocks as judged by the Vanguard Total World Stock ETF (ticker: VT) hit correction territory on 2/9/2018, -10.53% from previous highs.
When there is a sharp, sudden, seemingly out of nowhere pullback in the markets investors should ask themselves one big question.
What is fundamentally different about the market environment looking forward than before the pullback began?
If the answer to the above question is nothing, then it is very likely that this is a correction and not the early stages of a bear market.
Market corrections historically have occurred almost every twelve months. They are normal, they are volatile, and they are impossible to forecast on the front end. However, they are recognizable in the moment.
When faced with downward market volatility i.e. a correction, the best course of action is to wait, hold, and/or put sidelined cash to work.
– Wyatt Swartz
– 2/15/2018
On Tuesday Feb 6th, 2018 I sent an email message to the members of the W. Swartz & Co. Private Client Group regarding the current market volatility. Below is that message.
Hi Friends,
As you likely heard via the news media or talk around the water cooler we have seen world stocks as judged by the Vanguard Total World Stock ETF (Ticker: VT) drop -6.6% since Friday 1/26/2018 to yesterday 1/5/2018. Today we saw it bounce back that puts us at -5.24% since the decline began.
A short, sudden, “out of nowhere” drop in the market is what we call a correction. Formally, a correction needs to hit -10%, but I define it behaviorally based on the previous mentioned criteria. Perhaps we still will hit that -10% level, or perhaps we’ve already bottomed out. Trying to forecast a correction (on the frontend) is a fool’s errand, and picking it’s bottom is about just as foolish.
However, recognizing a correction when it happens and not panicking, can allow for tactical maneuvers that help performance. Most importantly it helps stop the investor from making the classic panic mistake of selling low and buying high. I successfully called the last three corrections, US Presidential Election, Brexit, and China “Slowdown” Worries. See these past Insights Posts: Overreactions & Opportunities Potter’s Buying, Still Smells Like a Correction, Market Conditions Update – 7/20/16
In times like this there is one question that needs to be asked. What today is different about our global markets view than a couple weeks ago when markets were climbing? If the same general story applies and it does in this case then we are usually looking at classic market correction territory and not bear market territory.
In this case, our worldview hasn’t changed. Probabilities for global recession remain low, growth seems to be picking up in pace among international economies and remains strong at home. Weirdly there are pundits on TV (most cases not professional investors, simply TV personalities) which are attributing the downturn to good news in the latest job report and in wage growth. Yes that’s right, pundits are attributing the downturn to good news.
In US Stocks the recent pullback has brought valuations down to around 17.7 times forward earnings (F P/E), this is a little higher than long-term averages, but well below 27.2 times forward earnings valuations we saw the last time there was a full market cycle in 2000. International developed and emerging markets are still below their long-term forward price to earnings multiples.
Mr. Market is tricky, and I/we can always be wrong. That’s why asset allocation, and diversification is so important especially when there are upcoming cash flows to consider.
Could this be the start of a bear market? Yes it could. Do I think this is the start of a bear market? No, it looks like a classic correction to me. Corrections are normal, volatility is normal. The occasional correction could actually help to extend the life of the bull market.
As always, feel free to reach out with any questions or concerns.
All the Best,
Wyatt Swartz
Message sent to members of W. Swartz & Co. Private Client Group on Tuesday Feb 6, 2018.
For some context, markets as judged by the Vanguard Total World Stock ETF (Ticker: VT) did hit full correction territory of -10.53% on Feb 9, 2018. As of this writing (2/15/18) it has rallied +5.26%.
– Wyatt Swartz
– 2/15/2018
Benchmark for stocks portfolios: Vanguard Total World Stock ETF (Ticker: VT): +24.49%
About the Benchmark: VT is an ideal benchmark for the world stock market. It is a global stock index fund that covers approximately 98% of the world’s investable market capitalization. About 50% of the fund’s portfolio is invested in U.S. stocks, 40% in international developed stocks, and the remaining 10% in emerging-market stocks.
Benchmark for fixed income portfolios: iShares Core US Aggregate Bond ETF (Ticker: AGG): +3.53%
About the Benchmark: AGG provides a measure of the performance of the U.S. dollar denominated investment grade bond market, which includes investment grade (must be Baa3/BBB- or higher using the middle rating of Moody’s Investor Service, Inc., Standard & Poor’s, and Fitch Inc.) government bonds, investment grade corporate bonds, mortgage pass through securities, commercial mortgage backed securities and asset backed securities that are publicly for sale in the United States.
W. Swartz Total Return (WSTR): +23.25% (after fees)
About this Portfolio: This portfolio is 100% stocks and used in accounts I manage where the client has about $250,000 allocated to stocks. It is the flagship portfolio of W. Swartz & Co.
Why the Underperformance? The primary cause of underperformance vs. benchmark was due to an underweight towards Emerging Markets vs. the benchmark. Emerging Markets were the top performing class when comparing US vs. International Developed vs. International Emerging.
BRAVO: +23.13% (after fees)
About this Portfolio: This portfolio is 100% stocks and used in accounts I manage where the client has below $100,000 allocated to stocks. It will mirror the WSTR portfolio in theme, but with fewer holdings.
Why the underperformance? Two primary causes.
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1. These client portfolios had underperformance because “timing” of contributions and trades. Since the benchmark generally speaking took a very steady/smooth path higher during the course of the year, the BRAVO portfolios/accounts were negatively impacted by having ongoing contributions as those contributions were unable to get the full year’s positive returns.
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Example: Account 100% allocated to the BRAVO portfolio starts year with $50k balance, but has another $15K contributed during the course of the year. That additional $15K did not get the benefit of previous returns that occurred before the contribution/investment date.
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A underweight to emerging markets vs. the benchmark contributed to underperformance. In terms of US, International Developed, and Emerging Markets, EM was the top performing category and the portfolio was underweight there.
CORE Fixed Income: +3.68% (after fees)
About this Portfolio: This portfolio is 100% fixed income correlated securities. Meaning that it may not be invested in individual debt securities, but rather pools of debt securities in the form of ETFs &mutual funds. This portfolio uses the Vanguard Total Bond Market ETF as a benchmark.
Why the Outperformance? Overweights to high-yield, and corporate bonds vs the benchmark led to outperformance.
Individual Stocks: +27.93% (After Fees)
About this: This is the performance of the individual stock holdings within WSTR. Within the WSTR portfolio, the individual stock positions weighted equally (which they are within WSTR) achieved the above after fees return.
Why the Outperformance? One of the ways an investor can achieve alpha, that is outperformance compared to a benchmark if through stock selection. Meaning picking stocks that do better than the benchmark/overall market. This was the case for the individual holdings within the WSTR portfolio in 2017.
Conclusion: While I would have preferred to see all portfolios outperform in 2017, every portfolio performed in line with benchmark. First and foremost it is my job to ensure that clients get the type of returns they are supposed to get over long-term periods. All portfolios were successful in achieving that purpose. The average investor has drastic underperformance over short and long-term periods.