In January, we wrote to you about 2018’s fourth quarter meltdown, and three months later the markets reversed course and shot higher.
Two of the main issues that plagued the market in Q4 2018, tariffs and the Fed, have moved to the back burner. First, although there are mixed messages coming out of Washington and Beijing, there does seem to be some momentum towards resolution of the trade impasse. The cooling trade war, coupled by a hold by the Fed of additional rate increases, has the market back feeling good. The US equity market ended Q1 2019 about 13% higher than where it ended in December 2018—which marked the worst quarter in 10 years. Further, Q1 2019 has been the best quarter since 2009.
We also recently marked an important anniversary. Ten years ago, the Great Recession ended. On March 9th, 2009 the S&P 500 index, a broad index representing the largest 505 companies in the United States, hit an intraday low of 666. That same day the index closed at 676 and it marked a significant decline from the market peaks reached in the fall of 2007. All told, during the Great Recession the index lost over 50% of its value in 16 months. It is important to reflect on the 10-year anniversary of the Great Recession considering the impact it had on investor portfolios and recognizing that it still impacts investor behavior today.
Let’s go back to the fall of 2007. We were several years past the dot-com bubble, a significant correction in its own right, marked by a technology correction in 2001 in which companies with limited or no actual earnings brought stock prices across the board to their knees. But in the fall of 2007, all was forgotten. The housing market was on fire, which served as the lead story many nights on the evening news. In 2005 alone, over 180,000 homes were flipped and the average gain on a flip (home bought and sold within 12 months) was over $60,000 per transaction. It appeared this ride would go on forever.
Wall Street and banks were there to help add gasoline to the fire with lax lending standards that only stoked the flames of speculation. Homeowners were benefiting from this activity by being able to tap into home equity with adjustable rate mortgages. This was a crucial factor in the Great Recession bubble as the consumer makes up roughly 70% of the US economy. A consumer who owns a home and can tap into equity creates artificial financial activity that leads to further consumer debt and gives a short-term boost to the economy in the way of short-term spending.
As the cycle accelerated, Wall Street facilitated this artificial boom further with use of products like Credit Default Obligations and Credit Default Swaps which, in short, created additional liquidity and facilitated this easy money mentality. If it all sounds like a house of cards, in retrospect, it probably was. After the market melted down and we surveyed the carnage the toll was extreme. Over 8 million Americans lost their jobs; the $8 Trillion housing market popped; and as mentioned, the stock market lost over 50% of its value. Many homeowners lost the safety and security of home ownership.
The pain of the Great Recession has left a lasting scar. To this day, we at AAFCPAs Wealth Management continue to be asked to predict the next great recession. Investors affected by the dot-com bubble and the Great Recession have been left with the impression that the market grows, the market plateaus, and then the market has a major correction. This does not have to be the case. In January, we reflected on the number of recessions we have had as a country and we reviewed the severity of those contractions. It is true that the business cycle has 4 distinct periods – expansion, peak, recession, and trough. We are likely in a late cycle expansion but there is no expiration date on when this expansion will end.
Even though most investors have earned back most or all of what they lost (unless they mistimed the recovery and sold during the trough), the damage done in 16 months was extreme. Investors are left uneasy about the potential for the next big one. One thing is clear: the next big correction will not likely be directly related to arcane mortgage products and large scale failed financial institutions. Much of the systemic risk has been mitigated by extensive banking regulations and bank stress testing.
Our job at AAFCPAs Wealth Management is to build an all-weather portfolio that allows our clients to meet their short- and long-term goals. We carefully consider the amount of risk each portfolio has and how the portfolio will react if we were to go through another market correction. It is important to maintain this disciplined approach throughout the entire business cycle.
Volatility is nothing new. Volatility presents perceived opportunities and risks for market timers who seek to profit by predicting the next swing in market cycles. They must guess right twice—when to sell and when to buy back. For a long-term investor, volatility has far less impact on performance through all market cycles.
If you have any questions about your personal financial plan, please contact: Carmen Grinkis, PhD, CLTC, CFP® at 774.512.4061, firstname.lastname@example.org; Andrew E. Hammond, CFP® at 774.512.4143, email@example.com; or your AAFCPAs Wealth Advisor.