When stocks sell off, everybody wants to know why. Last week’s selloff is being blamed on everything from the collapse of the peso in Argentina to a contraction in manufacturing in China to disappointing Q4 earnings announcements in the U.S. Whatever the case, the bigger concern is how long the selloff will last.
Of course, nobody knows for sure how long any selloff will last. To keep things in context, keep in mind that stocks rallied about 30% last year. That’s a rather large one-year return. Over the long term, stocks tend to rise by approximately 8-10% annually. But that is just the average. Average, of course, implies variation. For example, if stocks go up 10% every year for 10 years in a row, the average return is 10%; but in this case, there is no variation. This would be a highly unlikely occurrence. On the other hand, if stocks fall 5% every year for five years in a row and then rally 25% per year over the next five years, the (arithmetic) average annual gain is still 10%. This, too, would be a highly unlikely occurrence; however, in this case, there is variation. Notice also that in the second case, even though the average is 10%, there was no actual year in which stocks rallied 10%.
The point is that selloffs are inevitable. As Warren Buffett has said, long-term investors should welcome selloffs. It gives them the opportunity to buy more shares at lower prices. No one, however, can consistently pick the tops and bottoms. When you buy stocks following a selloff, you run the risk of getting in too early.
The S&P 500 is down only about 3% since the year began. Many pundits have been calling for a 10% correction. Even long-term bulls view 10% pullbacks as healthy. We’re still a ways from that point so the selling could easily continue for a while. In 2013, the stock market rallied strongly even though the economy showed little signs of health. This year (so far), the economy is looking better. However, that does not imply further gains in stocks. To a large extent, last year’s rally anticipated an improving economy.
Right now, we are in the heart of earnings season so we can be sure to see more volatility in the days and weeks ahead. Furthermore, Ben Bernanke’s last FOMC meeting as Chairman of the Federal Reserve occurs on Jan. 30. The Fed has embarked on a course of reducing the amount of quantitative easing. The market currently expects the Fed to announce an additional $10 billion reduction in easing. That means, the Fed would continue buying bonds at the rate of $65 billion per month. One thing is for sure. If the Fed chooses some other course of action, stocks will respond very quickly one way or the other. In fact, if the past is any guide, stocks could shake, rattle, and roll even if the Fed does exactly what is expected.
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The views expressed here are that of myself or the cited individual or firm and do not constitute a recommendation, solicitation, or offer by myself, D2 Capital Management, LLC or its affiliates to buy or sell any securities, futures, options or other financial instruments or provide any investment advice or service. D2, its clients, and its employees may or may not own any of the securities (or their derivatives) mentioned in this article.
The Jacksonville Business Journal has ranked D2 Capital Management in the top 25 of Certified Financial Planners in Jacksonville. The Firm is also a member of the Financial Planning Association of Northeast Florida, the Jacksonville Chamber of Commerce, the Southside Businessmen's Club, and the Beaches Business Association.
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