What A Client Asked Me The Other Day

A client asked me the other day about the possibility of a 20-30% correction in the markets in the next five years.  The question was in response to some article he'd read that noted many of the gauges reportedly used by Warren Buffet show the market historically overvalued.  Please note that I don't know what article he's referencing.  

Here's my response:

"I will tell you that at some point over the next 5 years there is a very high probability we'll have a market correction that has the potential to be between 15-30%.  The historic volatility of the market is around 15%, meaning that in any given year there is a very high probability of a stock correction around 15%.    At 4,377, the S&P 500 experiencing a 25% correction would  take the index back to 3,283.  That would take the market back to about where it was in November 2020.  Of interest to that level is that's also where stocks traded in early 2020 before the pandemic became a problem.  The trick in any decline is trying to figure out if we're in what would be described as a typical correction in prices or a set of circumstances that would morph into something much worse.  To get much worse in my opinion you typically need a few things to happen.  You need an unexpected event or usually the unraveling of a financial bubble in assets.  If there's a bubble in any asset classes right now it's in certain speculative stocks and perhaps crypto.  While exciting for some these areas of speculation don't draw in enough money to pose a systemic problem to the investment world.  In terms of an event posing a systematic risk, you'd need something out of the blue like a foreign policy crisis or the virus taking a unexpected and deadlier turn I think for us to see a major impact on stocks.

As for quoting Buffett, Warren has said a lot of things over the years but I like his comments on volatility and I trot these out for clients in periods of market weakness.  Traders tend to love volatility but investors hate it when it leads to a decline in their accounts.  Presumably nobody minds volatility when stocks move higher.  As for Buffett and what he's said on stocks and volatility, here you go.

'The unconventional, but inescapable, conclusion to be drawn from the past fifty years is that it has been far safer to invest in a diversified collection of American businesses than to invest in securities — Treasuries, for example — whose values have been tied to American currency. That was also true in the preceding half-century, a period including the Great Depression and two world wars. Investors should heed this history. To one degree or another it is almost certain to be repeated during the next century.

Stock prices will always be far more volatilethan cash-equivalent holdings. Over the long term, however, currency-denominated instruments are riskierinvestments — farriskier investments — than widely-diversified stock portfolios that are bought over time and that are owned in a manner invoking only token fees and commissions. That lesson has not customarily been taught in business schools, where volatility is almost universally used as a proxy for risk. Though this pedagogic assumption makes for easy teaching, it is dead wrong: Volatility is far from synonymous with risk.  Popular formulas that equate the two terms lead students, investors and CEOs astray.”

*Long ETFs related to the S&P 500,  in client account and personal accounts, although positions can change at any time    We reserve the right to change these investments without notice on this blog or via any other form of verbal, written or electronic communication.