The Dos and Dont’s of Approaching the Market During Volatile Times


In this episode of the Science of Economic Freedom, “Volatility Ahead of the Election,” we discuss what you really need to do right now—and you’ll be surprised to learn that it doesn’t have much to do with buying and selling equities.

Some of the key issues we cover in this episode include:

  • A rundown of the numbers in the major indices, and how the second correction in the equity markets this year is playing out.
  • How to reinterpret hyperbolic headlines and why this market correction is normal.
  • How our “factor investing” approach to markets helps Mercer Advisors manage client portfolios during market downturns.
  • Should investors be doing anything differently right now from an asset allocation standpoint?
  • What could happen to stocks if Democrats gain control of the House of Representatives?
  • The prognosis for emerging markets over the next couple of years.
  • Why you shouldn’t be worried about the daily action in stocks prices, and why you should be focused on what you are in control of in your financial life.
  • The “dos” and “don’ts” of how to approach the markets—and your financial life.

These issues, and much more, are discussed in much greater detail in our new feature on the Mercer Advisors’ website, and it’s our latest client webinar. This webinar was recorded this week, and features Chief Investment Officer Don Calcagni, Chairman Emeritus Drew Kanaly, and Podcast Host Doug Fabian.

To listen to this client webinar, simply click here.

Podcast Transcript Episode 35

Is the current volatility in the stock market a precursor to the next bad event? Are you worried or concerned about the election and its outcome on the economy and the markets? Do you feel nervous about what to do next in your investing portfolio? Stay tuned to this episode of the Science of Economic Freedom. The Science of Economic Freedom is intended as an investor education resource. The views and opinions expressed on this program should not be construed as a recommendation to buy, sell or hold any specific security. Consult your investment advisor and read any investment prospectus carefully before making any changes to your investment portfolio.

This program is sponsored by Mercer Advisors. Mercer Global Advisors Inc. Is registered with the Securities and Exchange Commission and delivers all investment related services. Mercer Advisors Inc. Is the parent company of Mercer Global Advisors Inc. And is not involved with investment services.

Welcome to the Science of Economic Freedom. I’m your host, Doug Fabian. This podcast is all about helping you achieve your financial dreams. We call that economic freedom. This program is about your journey to achieve economic freedom for yourself and your loved ones. Today, we want to help you identify your next step on that journey. This is Episode 35: A Market Update, Volatility Ahead of the Election. There are now 49 episodes of the Science of Economic Freedom posted at our website and we’re coming up on the one-year anniversary of the show.

Now, today’s show will be all about the markets and you. Stocks have been volatile of late. There have been days that stocks have been down triple digits when viewed through the price action of the Dow Jones Industrial Average. There are headlines about why and predictions about what will happen next. This is typical not only of volatile times but of October as well.

Now, this show is not just about what’s happening in the stock market, it’s about you. How will you react to this latest bout of volatility? What is happening inside of your portfolio and inside of your head? Are you worried about what’s to come from the election? Are you fearful of another 2008 right around the corner or are you enjoying your life and not worrying about the markets, your portfolio or what might happen over the next couple of weeks? I hope it is the latter.

Now, let’s get right to the numbers. Stocks have been correcting as late and this is the second correction of 2018. Now, these statistics are through 1024 of 2018. The S&Ps 500 is down 9.2% since its all-time high on October 3rd. The Nasdaq has corrected 12.3%. Now, just a reminder, the Nasdaq is a tech heavy momentum-driven stock market index and a more severe correction there should be expected. There are headlines like these: The Dow plunges 2,368 points from its peak versus a headline that I would write about the markets right now,

The Dow has had a normal correction of 9%, something that happens almost every year in the stock market and it may not be over. Now, international stocks have gone down more than the US. The ITHA [Phonetic 00:03:33] index of developed markets is down 17% from its high in January. Global markets have been under pressure from rising US interest rates and a stronger US dollar. Emerging markets are down 23% from their January 2018 high. This correction in emerging markets is normal since emerging markets are higher beta stocks, more growth-oriented and they act more like small cap stocks compared to US stocks.

Once you remove the hype, forecasts and predictions, the correction of late in stocks is normal. Now, here are some resources for you to visit if you want more context around a market correction and the state of the markets today. There is episode 28, How to Navigate a Stock Market Correction. There is The Science of Economic Freedom Episode 31, Good Things Happen in Bad Markets. And we have a brand-new resource for you.

Yesterday, Mercer Advisors recorded a client webinar with Don Calcagni, our Chief Investment Officer and Drew Kanaly, another member of the investment team and myself, and we recorded that webinar, which is a deep dive into the current market performance, economic landscape and the effects of rising interest rates on stocks. We have included a link in the podcast email or you could visit merceradvisors.com and click on the Insights tab, that’s where you’ll find this webinar.

On yesterday’s webinar, we had many questions from clients and believe it would benefit you to listen to some selected questions and answers. Here we go. Given the valuation of growth stocks, which is higher than the valuation of value stocks, why are we not substantially shifting our portfolios out of growth and into value. This is a very reasonable question but remember, at Mercer Advisors, we follow the factor investing approach.

The largest segment of our portfolios when factor-investing is value stocks but we do have momentum or growth stocks in that portfolio as well. Now, if we were to just drop value and ignore growth, we would go through periods of substantial underperformance. For example, 2017, if we would have just dropped out of growth stocks because value stocks look like they were a better value, we would have underperformed significantly. It was our exposure to both growth and value last year that gave us good market returns.

So, we don’t know what’s going to happen in the future and to abandon the growth stocks today would be a mistake, in our opinion, when you look at the long-term numbers. Next question. Why is Bank of America saying that 15 out of 19 indicators of a bear market have been recently hit. What are your thoughts? Well, one of the things that happens on the internet is websites are looking to get people to click. It’s called click bait. Bank of America has come out with this call. I saw it on a recent website that they believe 15 of 19 indicators are starting to point towards a bear market. Well, this is a forecast and a prediction.

They’re not giving you any direction of what you should do or how you should act and we believe that you should continue to invest towards your long-term goals. Now, if you have shorter term money invested in the stock market, that’s not where short-term money should be invested and you should always be focused on what your goals are. So, our advice, ignore what you’re seeing on the internet relative to 15 of 19 indicators of a bear market.

Next, is there a negative correlation between rising interest rates, slowing housing prices and equity performance? Well, we have gone through a period, if you look at the past 10 years, where interest rates had been held down, interest rates were brought down in order to be able to revive the economy. Now, economic growth is normalizing and matter of fact, economic growth is above trend. This is the opportunity for the federal reserve to normalize interest rates.

They’re not trying to make things difficult, they’re telling people that they can take off the life jackets, that there is no danger today that the economy needs to be on life support with exceptionally low interest rates. That’s just going to cause problems down the road. So, the normalization of interest rates is something that we should get used to. Now, in the normalization of interest rates, we are going to have higher mortgage rates and that is going to slow the economy in some sectors like housing but that doesn’t mean that it’s going to change the trajectory of the economy going forward. So, continue to hold the course.

In light of these varied gyrations of international events, tariffs, oil production, consumption predictions, interest rates, could you reiterate what we investors with our international diversified asset allocations, should now compare to in the past? What this question is relating to is the fact that the international portions of our portfolios are underperforming US stocks and there is a lot of headlines about tariffs and trade wars and oil prices and these kinds of things. I believe that the person asking the questions is really saying, should we continue to hold these international stocks? Well, the answer is, absolutely, yes.

When you look at the valuations and this is one of the things we talked about in detailed and showed some exhibits on the webinar, when you look at the valuations of international stocks, emerging stocks are the most undervalued, international stocks next and US stocks are higher in valuations compared to the other two. But when you look at the long-term performance of emerging markets, international and US, they compare similarly over long-term time frames.

So, with that backdrop, this is an indication that we’re going to see, sometime in the next couple of years, an outperformance of international and emerging markets versus US stocks. That’s what happens. This is what happened in 2017. International and emerging markets were better than US stocks. So, we should not abandon our long-term strategy because we’re going through a short-term period of underperformance relative to international stocks. And also, international stocks help us stay diversified.

Next question. Explain how Mercer Advisors rebalances portfolios and why this is important? Well, one of the things that we talked about on the webinar yesterday is rebalancing and we do believe that rebalancing is important. One of the things that we did at the beginning of this year after we had strong performance from the equity markets in 2017, is we sold some stocks. When I say some stocks, I’m talking about a percentage of the portfolio, maybe it was 3%, maybe it was 5%, and shifted that allocation to bonds.

The reason why we did that is because the outperformance in 2017 got the asset allocation of many of our clients’ portfolios out of balance. We had too much stock exposure. That’s the reason why we rebalance. The same thing is true after every quarter, we do some rebalancing. Now, at the end of this quarter, when stocks were at all-time highs, we’re continuing to look at the asset allocation and rebalancing and maybe the shift is even less.

Maybe it’s only a 0.5% we sold of stocks or 1% we sold of stocks but we’re continuing to constantly rebalance the portfolio to keep it on track with the appropriate asset allocation for our clients. That’s what rebalancing is all about. One of the things that happens with investors is they go through periods of time where they might have a single asset in their portfolio, could be an individual stock, it could be a highly-concentrated position and they’re allowing that highly concentrated position to run because they don’t want to pay taxes.

But then that highly-concentrated position or that overallocation to stocks makes the portfolio more vulnerable to volatility and makes people uncomfortable when we go through volatile times. This is why we rebalance on a systematic basis. Here’s a question about the upcoming election. If the Democrats take over control of the house in the midterm election, will the stock market slide lower?

Well, one of the things that we did during the course of the webinar is we did some comparisons in stock market history to whether or not Republicans were in control of Congress and the White House, whether or not Democrats were in control of Congress and the White House or whether or not we had divided government. The fact of the matter is there were very small differences between these groups. We’ve gone through bull markets with Republicans, we’ve gone through bull markets with Democrats, we’ve gone through bear markets with both groups and with divided government, we’ve had good times and bad times.

Your money and your investing strategy does not care what’s happening in politics. Now, I realize that many listeners to this podcast right now do care and I understand that. That’s your point of view. No problem. But don’t feel as though you have an edge or you have a headwind because of some recent election. There is no evidence. There is no scientific data when you look at the last 200 years of stock market action, that it matters to your investing portfolio who is in the White House.

What matters is we continue to innovate and innovation is one of the things that is continuing to happen in our lives each and every day, so that’s a good thing. Now, here’s a question that relates to government deficits. Assuming that the US government will always spend much more than it takes in in taxes, what is the long-term Mercer Advisors strategy for this issue? Now, one has to assume that deficit spending, money printing and borrowing will continue, do you see any investment strategy that accounts for a currency collapse?

Well, one of the things that we have had in this country and in many countries, I’ll even say most countries around the world, we do have deficit spending. Much of that deficit spending has to do with entitlements and promises. There has been no political will for any administration to deal with the cutbacks on promises from Social Security and Medicare. Matter of fact, there are more promises that are put in place all the time. So, there’s just no way to be able to predict what’s going to happen in the future.

One of the important issues to understand about the deficit right now is the economy is continuing to grow. Matter of fact, the economy is growing faster than government spending. Therefore, we have a larger engine of economic growth that is driving tax revenue and when you take a look at a currency collapse, this is one of the things that I want people to understand about currencies, there are many currencies in the world and there are few governments in the world that have a budget in balance. The US continues to enjoy the fact that we have the reserve currency around the world.

So, this is a question that can’t be answered. Can’t predict what’s going to happen in the future. One of the things that we want to do is we want to continue to be diversified and if we have inflation stocks are a great hedge against inflation and if we continue to innovate, we’re going to continue to have a growing economy. There’s going to be volatility along the way and there’s going to be a ceiling on interest rates because when interest rates go up too high, it’ll start to slow the economy again. So, we’re going to continue to move forward with our strategies. We’ll make adjustments as we see fit but this is really not anything to worry about right now.

Next question. Where do we see the current downtrend in the market going? Well, there’s absolutely no way to be able to answer this question. As I said at the top of the show today, we’ve had a 9% correction. This is the second correction that is approaching 10% in this calendar year. As I talked about at the beginning of this year, it has now been 10 years since the last major bear market and bear markets have a tendency to occur about every six to seven years.

So, a lot is going to dependent on what happens in the economy going forward. But this correction in the context of a growing economy in rising earnings, does not have the precursor of another bear market today. Now, could this correction go down 15% or could it go down 20%, absolutely it could. But it is best to look at your investment strategy and how your investment strategy performs in good markets and in bad markets and it’s important for you to stay diversified and have the right asset allocation. That’s the portion of your portfolio that you should be focused on right now.

What is the prognosis for emerging markets in the next couple of years? As I said at the top of the show when I reviewed the statistics, emerging markets are underperforming this year. Matter of fact, emerging markets are down more than 20% but they were up almost 40% last year. So, they are higher beta, which means they are just more volatile. They give you more growth but they also give you more severe corrections.

Right now, emerging markets, of the three categories of stocks internationally, including the US, is the category that is of the lowest price to earnings ratio. So, you could say that emerging market stocks are of the best value but that doesn’t mean you should load up on emerging market stocks. You should have them in balance with your other asset allocations. But I would say the prognosis for emerging market stocks, going forward, is good. Last question. Let’s discuss the election.

As I mentioned earlier, Republicans in control, both bull and bear markets. Democrats in control, both bull and bear markets. Divided government, both bull and bear markets. We should not bring our political views into the management of our portfolio. Your money doesn’t care who’s in the White House, your money doesn’t care who’s in Congress. Certainly, any sort of election surprise could bring in some short-term market volatility but things will once again return to normal.

The question is, should you be worrying about the daily action in stock prices? The answer is no. You should be focused on what you can control in your life. What could you be doing today, tomorrow or the next day, to move closer to your long-term or short-term goals? How can you make a positive impact on yourself, your family or in the lives of others? Or you could just want to enjoy life, so no pressure here to do something. There are things in life which you are in control of and things in life that you are not in control of. When it comes to investing, the scientific evidence is clear. Making a knee-jerk reaction to short-term price swings in stocks does not increase your investment returns, it actually hurts your investment returns.

Now, here’s something that I want you to pay attention to. I have heard a reoccurring theme of late. I’ve heard it from many sources. I’ve read it in recently published books. I’ve heard it mentioned on TV. I’ve heard it on the radio and I have witnessed and verified this anecdotally. We are living in the greatest period of prosperity in the history of humankind. There is more innovation today, there is better health today, there are fewer conflicts today. There is less war, less human suffering than any point in time in history.

Now, if you could choose any point in time in history in which to live, I believe most people would choose to live now. So, what’s the problem? Why are we so stressed out about what’s to come next in the stock market? There is no need to be. Now, here are your action steps from this week’s show and I boiled your action steps down into two categories, things you should do and things you should not do.

Let’s start with the don’t-do list. Don’t get inside your head and think, “This time the decline in stocks is something different other than normal price action.” Don’t allow corrections, volatility and headlines to take you off course from your goals. Don’t listen or watch predictions about what’s to come next.

Now, let’s talk about the things you can do. Do feed your mind with positive stuff. Listen to this podcast. Go to the suggested episodes that I talked about today. View the webinar that is fresh, we just posted this webinar yesterday and stay the course. Do revisit your short-term and long-term goals to find out what really matters and do take the time to enjoy life, your family, your friends, and tune out the noise.

This is Doug Fabian, thanks for listening. The Science of Economic Freedom is intended as an investor education resource. The views and opinions expressed on this program should not be construed as a recommendation to buy, sell or hold any specific security. Consult your investment advisor and read any investment prospectus carefully before making any changes to your investment portfolio.

This program is sponsored by Mercer Advisors. Mercer Global Advisors Inc. Is registered with the Securities and Exchange Commission and delivers all investment related services. Mercer Advisors Inc. Is the parent company of Mercer Global Advisors Inc. And is not involved with investment services.

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