We wanted to take this opportunity to provide some context around current market action and news headlines. Given the recent volatility in global equities, it is natural to wonder if we are entering a period of extended declines. We don't know the answer to this question; no one does. The financial media is notorious for assigning a single specific cause to a market decline. A month ago the target was Greece. A year ago it was Ebola and before that the Japanese nuclear crisis. The current nemesis is China and its slowing economy.
The important takeaway is that markets frequently deal with uncertainty and re-price lower in the short term as they digest new information, but ultimately, in the long term, market and economic fundamentals take over. This happens because the world economy grows over time due to technological, financial, and human capital coming together to grow profits or make new ones. Investing relies on this single premise and over the market history, diversified portfolios have been rewarded, especially those built with the kind of “preserve and grow” investment philosophy that characterizes Ropes Wealth’s approach. Single companies and their individual stock can go to zero, but it is not likely that the collective world stock market will. And while the steep declines of 2008 and early 2009 are certainly still scars we all bare, it is important to remember that such events are not the norm.
After an extended bull run, many investors forget stock markets periodically see intra-year declines in the 5-10% range. 5% declines happen, on average, 4 times per year with an average recovery period of 2-3 months. 10% declines happen on average about once per year with an average recovery period of 8 months. Given current market action, it appears our honeymoon of low volatility may be over, but that doesn’t mean our outlook for the long-term return opportunity in the markets has changed.
In the U.S., second-quarter earnings have been coming in above very conservative expectations. The Fed seems amenable to raising short-term rates without slowing economic growth. Equity valuation (on forward earnings expectations, the measure we think matters most) at 18x is near the middle of its 20-year band. Profitability is high but, in our opinion, not driven (yet) by cyclical considerations nor likely to normalize in the near future. In short, the forces that drove U.S. stocks higher in the past several years may be diminished, but they are not gone and, we believe, are not likely to turn negative soon.
In developed Europe and Japan, valuations have appeared cheap for several years versus the U.S. Tight fiscal policy, a paucity of offsetting positive monetary policy, lack of quantitative easing, and a reluctance of banks to lend to small businesses were among the overhangs dragging down the outlook. These issues are receding or disappearing in large part; and, if we are right, so should the relative attractiveness of the developed international markets in the next 12 to 18 months.
For sure, China presents a potential problem that is hard to fully analyze. However, investors should remember that a strong central government, acting to firewall China’s economy from its financial markets and its financial markets from its economy, can very well be successful. In our opinion, that was the case in the U.S. in 2008. We would not discount this possible outcome in China today. Other selective emerging markets still offer value and, we suspect, significant potential appreciation over the next several years.
In times like this it is important to remember your investment plan is designed to carry you through decades not days. Therefore, the most important advice we can provide in all market environments is to make sure the investment plan in place reflects your goals and that we are keeping that plan up to date as your circumstances change. We are here to answer your questions and concerns, today and always, so feel free to contact us +1 617 235 4260.