Updated: Nov 29, 2018
The market's recent sell-off can be attributed in part to the following:
Rising Interest Rates - There has been a steady increase in rates since the beginning of the year.
Large Move in S&P 500 in Short Time -The market (measured by S&P 500) was up by 9.5% this year through September and up about 13% from its February 2018 lows. This is a big move in a rather short period of time .
S&P 500 YTD
Profit Taking - Investors want to lock-in gains and become nervous at the first sign of a correction. This is especially true with the NASDAQ, where a lot of performance year to date has been driven by Facebook, Amazon, Apple, Netflix, and Google, and whose recent downward price action has caused investors to become skittish .
NASDAQ 100 YTD
Import Tariffs - Investors are not sure how the possible tariffs on imports may affect multi-national companies and in turn sustained strong economic growth, causing additional uncertainty.
No Place to Hide- Virtually all asset classes worldwide are down this year in US Dollar terms. From a recent WSJ Article, "90% of the 70 asset classes tracked by Deutsche Bank are posting negative total returns in dollar terms for the year through mid-November, the highest share since 1901." In the United States, both stocks (as represented by the S&P 500) and bonds (as represented by the Barclays Aggregate) are both down and may be the first time in 25 years where both are down for an entire year.
What does this mean and what should we expect:
Volatility in the markets is back and we should expect this to be the norm for at least the near future. Volatility by its nature tends to change very rapidly and unexpectedly. This is typical, healthy and essential to the markets' long term well-being.
We may very well see further erosion in stock and fixed income prices in the short term. Again, these corrections are both normal and healthy. Markets have performed exceptionally well over the last few years with few pullbacks. Investors invariably forget that corrections do happen and can be used as entry points to put new or additional funds to work.
Note there have been similar bursts of volatility and corrections; examples are the Volatility Spike of February 2018 and January 2016, Taper Tantrum in 2013, S&P Downgrade of USA in 2011). The key is to stick with your plan and make sure your investments are helping you accomplish those goals.
Below are some other ideas on how to help protect your portfolio:
Diversification - Your portfolio should be diversified and have allocations to multiple asset classes. With the run up in the market over the last few years, you may have neglected rebalancing your portfolio thereby holding an equity allocation that exceeds your intended risk level. Now is a good time to trim these positions and add back assets that act as ballast to your portfolio such as fixed income, real estate, or commodities. Of course diversification/asset allocation doesn’t guarantee a profit or insure against loss.
Increase Cash Allocation - Cash is a great diversifier and allows you to buy assets after they’ve declined in price. Think of it as being able to buy more because it’s now ‘on sale'. It also allows investors to sleep at night. Rates paid on cash have increased and are now a viable place to allocate a portion of ones portfolio holdings. Also, everyone should have an emergency fund made up of cash equal to 3-6 months of living expenses.
Add Fixed Income - Fixed income acts as ballast on your portfolio. It can provide a stream of income and is usually less sensitive to stock market gyrations. With interest rates moving higher, bonds are starting to pay a better rate. However, you need to be careful with duration, which is a calculation of how sensitive bonds are to rising rates. With rates probably continuing to rise, you will want this measure to be as short as possible.
Non-correlated Assets - Assets where the price movement of one asset has no effect on the price movement of another asset are considered to be non-correlated such as permanent life insurance. The payouts from these products are usually tied to something beside the stock market and usually involve some kind of guarantee. They are typically used for a long period of time and are generally less liquid than going to cash or buying fixed income. All guarantees are based on the financial strength and claims-paying ability of the issuing insurance company.
Risk Tolerance - Markets have climbed dramatically over the last few years, and many investors are now exceeding their intended levels of risk tolerance. With the markets showing signs of a possible extended pullback, now is a good time to check your asset allocation to make sure it’s properly aligned with your overall risk comfort level.
These are some other articles you may find interesting to read:
The S&P 500 Index (formerly Standard & Poor's 500 Index) is a market-capitalization-weighted index of the 500 largest U.S. publicly traded companies by market value.
The Nasdaq 100 Index is a basket of the 100 largest, most actively traded U.S companies listed on the Nasdaq stock exchange. The index includes companies from various industries except for the financial industry, like commercial and investment banks. These non-financial sectors include retail, biotechnology, industrial, technology, health care and others.
Aggregate Bond Index is an index used by bond funds as a benchmark to measure their relative performance. The index includes government securities, mortgage-backed securities (MBS), asset-backed securities (ABS), and corporate securities to simulate the universe of bonds in the market.