The End of the Honeymoon (Commentary)

We’ll start with a preamble. Since the election, one of the big difficulties we’ve had in our discussions with clients about the economy and financial markets is disentangling political feelings from non-partisan analytics. In any election, it’s natural for backers of the winning candidate to be more optimistic about the economy, while supporters of the losing candidate tend to be gloomy. In this election, the differences are more pronounced because the feelings on both sides were more tender. We recognize there are varying points of view, and we do our best to focus on hard data and clear analysis – that’s what clients expect from us.

As we’ve been suggesting for the past three months, we believe that there will be a lot of stock market volatility over the first half of 2017. It’s difficult to tell which aspects of the campaign rhetoric will be put into action, and many of the campaign statements are so radical that supporters and critics have trouble presenting clear analyses on their impact on the economy. However, until this week, the predicted volatility hadn’t manifested itself. That’s not surprising – the only real news before January 20 was about staff and cabinet appointments, and those selections lacked any clear direction about policy.

On Monday the market did react, negatively, to the news on the immigration ban. While the administration views the ban as a non-economic policy, there are definitive impacts on companies’ abilities to employ people impacted by the ban. So the stock market fell. It was the first significant market reaction to a policy change announcement by the new administration, and there will likely be dozens of such reactions, both positive and negative, to come in the next few months.

Implications for the near-term and long-term future

Again, we believe market volatility will be higher over the next few months. That being said, despite what many stock market pundits are saying, Monday’s reaction is not a definitive signal of things to come. The market declined by 0.6%. Looking at daily returns over the past 50 years, a movement in values of at least 0.6% happens 40% of the time. That means in a typical week, such a large movement (either upward or downward) is likely to occur twice. The decline by itself is not a big deal, and shouldn’t impact your investment strategy.

With respect to longer-term impacts, a reasonable question to consider is if there is a sustained decline in stock values over the next few months (or even years), how long would it take the market to recover? There’ve been five significant (at least 15%) for a sustained period of time (at least two months) stock market declines. This is not to say that the sixth such crisis is about to occur – in fact, we think that’s very unlikely. However, for those who are worried about a “worst case” scenario, the following table might be instructive:

That means, looking at the largest five market crises over the past five decades, on average, the market recovered within 37 months of when it first started declining. So if your time horizon is longer than three years (as it is for most of our clients), then even in extreme situations, markets typically recover before you need to use your investment dollars.

Our point is, even in the worst case scenario, we don’t think it’s prudent to completely restructure your portfolio. It’s important to note, that even with Monday’s decline, stocks have still earned a return of 7% since the election, which means maintaining a consistent strategy at that point was the best policy.

Should I Do Anything? Our fundamental belief is regardless of statistics and economic analysis, it’s important to be comfortable with the risk of your portfolio. It’s also imperative to separate political anxiety from valid concerns about the economy and markets. So after considering the discussion here, you still believe that you should make some adjustments to the risk of your portfolio, you should call your advisor. But we urge you to not overreact as well.

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An audio version of this commentary is available here >>>

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