What Do We Need To Accept About The Market in 2018?

Markets have certainly seen an uptick in volatility in the early months of 2018 with markets gyrating often hundreds of points in a single day.  Of course a hundred points on the major indices today is not what it once was on a percentage basis.  However, it is obvious that we are not operating under the same template when it comes to the markets that we saw last year.  Trying to game plan for the rest of the year, given what we currently know, means examining a series of different scenarios and assigning a certain probability to each. 

I think the most likely scenario is for stocks to spend much of 2018 consolidating their gains from the past two years.  The positives of underlying economic growth we are seeing and gains from the tax cuts runs into the worries of higher stock valuations, higher interest rates and higher inflation.  Also as the year ages we may need to weigh political risk into the equation from the upcoming mid-term congressional elections.  Once we get into the fall and once the outcome of the elections are priced into stocks there is a possibility we again attack the old highs from January.   Now obviously it is unlikely the year will pan out exactly as I've drawn the lines.   Still it seems there is a higher probability that a scenario similar to this unfolds.  In that kind of environment investors should prepare for higher volatility and a possible retest of February's lows at some point.  We've discussed other possibilities and outcomes over at our blog.  You can read about them here.

Given the kind of environment we may have entered I think investors need to do the following:

Accept that things may have changed.  Accept that there's a higher probability that stocks are not going to go straight up like we saw last year.  Accept that there's a higher probability of more volatility and that stocks may have seen there highs if not for the year then at least for some period of time back in January.  Accept that consolidation of gains is part of the process and just because we are not going up right now doesn't necessarily mean the bull market is over for stocks.  Learn to live with days where the major indices can drop 2-3%.  Again understand this is part of the process and the press will play this up.  A 500 point drop or even a 1,000 point drop today in the Dow Jones Industrial Average* gets a lot of headlines but doesn't mean what it once did in terms of percentage gains or losses.

Accept that you could take a look at your portfolio some time this year and see it down 10-15% or perhaps even more.  A 10-15% decline is historically what has been considered normal volatility for stocks.  It's been so long since we've seen that sort of drop that investors could easily be spooked if it should return or if we see something worse.  A decline of that magnitude would not necessarily mean the bull market is over or that we are necessarily going to see a larger drop in stocks.  Like everything else it would need to be viewed in the context of how it occurred.  Just know this is possible and a much more probable event given the current trading environment.

Accept that things may be changing in terms of market leadership.  We may not know if that's the case for many months.  If so then there should be time to address such a change unless we get some unexpected event over the transom.

Use market volatility to your advantage to either rebalance or reposition your portfolio if necessary.

Know what you own or how your portfolio is set up.  If the current volatility and more corrective conditions are keeping you up at night then you need to review your current risk/reward criteria.  If you're one of my clients then we need to discuss this.  If not, then talk to your financial advisor.  If you don't use one then honestly look yourself in the mirror or hire me!

Finally I would also say that you should take care that you're comfortable with where you have money invested that you might need in the next 6-18 months.  Choppy markets have a habit of seeing the most volatility when you might need the money the most.  For example, if you have a child entering college this fall and you've been able to save enough to pay for your share of the bill, then you might want to make sure that at least the first semester's tuition is invested in something right now that won't necessarily be subject to a market correction.  Of course this is an example and the situation will vary according to each person's needs.  An easy way to evaluate this is ask yourself in terms of money you might need in the short term what hurts more.  Would it bother you more to miss a 10% move up with money you might need soon or would the opposite hurt most?  If losing that 10% stings the most then think about getting more defensive with that money.

As I've also written recently I don't believe the bull market we've been in since 2009 is over but I also think there's a higher probability of markets hitting the pause button for a bit.  That is a normal part of the process.  If your comfortable in that analysis then perhaps nothing needs to be done but a bit of rebalancing or repositioning as the year progresses. 

Let me note my belief that  the biggest risk markets face would be an unexpected event washing over the transom.  One possible thing to now watch out for is rising political risk in the United States.  The President is no stranger to controversy and seems to thrive in a chaotic atmosphere that might unnerve others.  Whether fair or not the cumulative mounting evidence of discord in the current Administration has the potential to impact markets, particularly if the Administration starts to promote policies that are perceived to be unfriendly to stocks.   I also think so far it is underappreciated the higher probability that the Democrats could regain control of both the House of Representatives and the Senate this year.  In that case, we could find many of the Administration's policies either blunted or overturned.  It is not impossible to imagine a Democratically controlled legislative branch contemplating impeachment proceedings against the President.  None of this is meant to be political commentary.  I'm writing this to point out that rising political risk is perhaps not yet quite as appreciated in the markets or by investors.  I think it is something that bears watching as the year  advances. 

Away from this it is possible some of the President's personal problems  could mount a political toll that starts to impact either the economy or the markets.  Speaking of the President's personal life - let's discuss mixed drinks.   A Dark and Stormy is a form of cocktail using dark rum and ginger beer.  I'm not a fan but I have a brother-in-law who will drink one occasionally.  He thinks they're great.  The adult movie star Stormy Daniels may become a darker threat to the Trump Administration as the weeks pass. I'm assuming that all of you are familiar with Daniels' claim of an affair with the President and the alleged hush money she was paid in order to keep quiet about it.  As it is all over the press.  I don't right now see too many speculating on what happens if Miss Daniels is able to go out and tell her story unfettered of any potential hush agreement.  We don't know what details she might reveal or what proof she might have of an alleged affair.  We do know that many of the President's enemies are working as hard as possible to see that she gets heard and she has taped an interview with "60 Minutes".  She has also supposedly offered to give the alleged "hush money" back in an effort to go public with what she knows.  None of this will likely be flattering to the President if the story unfolds.

The last time we had issues of a President having an affair we almost had a President impeached.  It is hard to measure how this might damage President Trump or the Republicans going into the fall elections but markets don't like political scandals and are even more leery of these if they morph into a constitutional crisis.  Last week in a column I mentioned that the President's mounting personal problems could take a political toll that starts to impact stocks.  So far this does not seem to be the case but the crescendo behind Miss Daniels is only growing.  Something to keep an eye out for if these storm clouds become more intense.

And if you want a recipe for a Dark & Stormy click here!

Back Thursday.

*Long ETFs related to the Dow Jones Industrial Average as part of legacy positions in certain client portfolios.   Positions may change at any time without notice.