Market Pullbacks: Putting them in Perspective

Market Pullbacks: Putting them in Perspective

March 28, 2022
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During times of stress in the financial markets, clients and prospective clients often ask, “What is the plan?” or “What should we be doing?” The simple answer to both questions is “Follow the financial plan that has been carefully crafted and put into place to ensure you can live the life you wish to live.”

The price an investor is willing to pay to own a share of a business (equity) can fluctuate in the short term, but the value of great businesses (equity market) in aggregate increases (dramatically) over time. To enjoy the long term, permanent growth in equities, an investor must be willing to tolerate, and even expect periods of temporary declines. Since World War II, there have been twenty-two declines of between 10% and 20% and 12 declines of over 20%.One thing, however, remains true: The market has never, not made a new high (forgive the double negative). The chart below (Figure 1) shows how the market recovered after dropping more than 20% since 20001.

Figure 1:

To dive deeper into this line of thinking, let’s assume “the market” is the S&P 500 Index which is made up of approximately five hundred of the largest publicly traded companies in the United States (the actual number of companies fluctuates). For this example, we will use the iShares Core S&P 500 ETF (IVV) which is down 6.94% as of this writing from all-time highs. Assuming the market will make a new high at some point in the future, a share of IVV purchased at the close on Friday March 18th, 2022, will return almost 7.5% when the market gets back to its all-time high. The only true unknown is when.

Granted, this is a simple example, but the idea is sound and should provide relief from the anxiety that can wash over you when markets are volatile. Instead of wasting time worrying and wringing your hands over events you cannot control, focus on the positives and the knowledge that this time is NOT different. To reiterate, your financial plan was designed to withstand market pullbacks by taking multiple factors into consideration, including cash flow, emergency savings, and an allocation to less volatile asset classes like cash and fixed income. Short-term “noise” in the equity markets should not get in the way of long-term success.

Will the US economy enter a recession? Maybe, but maybe not. No one knows. Based on my family trip to Orlando last week, it certainly does not feel like it. Whether or not a recession is looming should not and does not affect your long-term financial plan. If we do see continued weakness, it should be viewed with optimism. It is an opportunity to invest in great businesses at lower valuations. If you have excess cash flow or savings, you are buying at cheaper valuations and higher dividend yields with every move lower. If you hold fixed income in your portfolio (you do), it can be an ideal time to rebalance those less volatile asset classes into equities.

Since World War II there have been thirteen recessions in the United States, so about one in every 6 years.2 The most recent was during the outbreak of Covid 19 but it only lasted 2 months. The previous and longest recession since 1945 took place during the Great Recession of 2008/09 and lasted 18 months. Yes, recessions do happen, but the good news is they are short-lived and give way to great innovation and growth.

“It’s All About the Long Term” is the title of a portion of Jeff Bezos’ original letter to shareholders in 1997. At that time, Amazon was proud to have served 1.5 million customers. Think about that number for a moment. The internet was in its infancy and Amazon was basically a bookstore. Now, 25 years later, Amazon is one of the largest companies in the world and the internet has become so ingrained in everyday life it is nearly impossible to imagine life without it. It is awe inspiring to think about all the innovation over the last several decades.

Growing up, I watched a futuristic animated cartoon called “The Jetsons” in which driverless cars, holograms, and talking robots were commonplace. Fast forward to today, and you might be passed by a car driving itself, with the speed limit displayed by hologram and the driver speaking to the car asking it to change the air temperature. Holding a diversified portfolio with a significant portion allocated to equities ensures you will own the innovators of tomorrow.

There are mountains of data that support the fact that investing in great companies via the publicly traded equity markets is a cornerstone to achieving long-term financial freedom. A picture paints a thousand words which is illustrated using the Russell 3000 Index (Figure 2).  As you can see, nearly every year has a period where the market temporarily declines, yet in 35 of the 42 years shown, the market ended up flat or in positive territory.

Figure 2:

When markets decline, hoarding cash, or even worse selling equity positions until the coast is clear, can spell disaster for financial success. We only need to look back to 2020 so see the most recent example. During the Covid 19 outbreak, the near future was quite uncertain and equity prices reflected that anxiety. An investor who let that fear get in the way (selling low) of following their financial plan not only missed the fastest recovery in history but had a permanent loss of capital!

It has been said that the best time to invest is when you have the money to invest. Attempting to wait it out or pick the perfect time to dip your toe into the market has been repeatedly proven to be a fool’s errand. Missing only a few days of strong returns can drastically impact overall performance (Figure 3). Peter Lynch once said “More people have lost money waiting for corrections and anticipating corrections than in the actual correction.”

Figure 3:

The main point I am trying to convey is equity markets can be volatile and market pullbacks are very normal and should be expected. Nobody said watching your portfolio temporarily decline is fun. An easy way to alleviate unnecessary anxiety is to turn off the TV and quit looking at your account every hour and go enjoy your time doing something that makes you happy. Financial reporters and journalists tend to report in a manner that causes fear buy using words like “crash” and “plummet,” or by interviewing a fund manager or “expert” that advises caution. A journalist’s job is to attract eyeballs. Oftentimes fund managers and supposed experts have very, very short time horizons. They are worried about day to day and quarter to quarter, when all that truly matters is the long run. No one can predict the future or knows what will happen next, but whatever it may be we will move past it. This may feel like a tough time to invest in equities, but that is usually a good sign. Although markets can trade lower, that only means your expected return in the future is that much higher. If you believe in capitalism and innovation there is no time like the present to make sure your equity allocation matches your financial plan.

1. S&P data © 2021 S&P Dow Jones Indices LLC, a division of S&P Global.
2. National Bureau of Economic Research

 

Author: Brian James, CPWA®

Brian James is a Managing Partner and the Director of Investments at Ullmann Wealth Partners. With more than 20 years of experience in the investment industry, he oversees the company’s investment management process which includes setting asset allocation, selecting investments and monitoring client portfolios. Brian earned an MBA at the University of Chicago’s Booth School of Business and is a Certified Private Wealth Advisor® professional.