As last week's global equity sell-off hit markets across every continent, major indices tracking worldwide markets produced their worst weekly declines in years. The sharp decline began in China, for many years the poster child of international growth, and spread rapidly around the globe. At close of business today — Monday March 5, major U.S. market indices were down 4% over the past week.
Was there a major news event behind this sudden, sharp decline? No. Market fundamentals remain unchanged. The origins of this hasty flight from the markets were rumors of tax law changes abroad and speculation about future recession in the U.S. economy. These rumblings triggered selling which led to more selling and an abrupt decline in investor mood and psychology. Some experts fear that this precipitous drop is a forerunner to the end of the current bull market which has run largely unchecked for more than four years since October 2002.
Our Observations
• While there is reason to be cautious, the U.S. economy still appears to be in good shape. Corporate earnings continue to be strong and dividends are for the most part increasing. Deterioration in the lower credit (subprime) mortgage market and continued declines in many housing markets have prompted some commentators to predict recession. However, as noted in this week’s Barron's Magazine:
“History suggests that stocks may do well in the next two months. Often the markets improve strongly in the months following a market decline. There have been 38 days since 1979 when the S&P 500 has suffered a single-session loss of 3% or more. The average gain in the ensuing 60 days has been 6.9%, with the index rising in 31 of the 38 cases, according to Citigroup research.”
• This global sell-off clearly demonstrates how closely allied the world financial markets are now. Diversification across a wide spectrum of equity markets alone is not enough to fully protect a portfolio in an age of multinational markets and instantaneous communication. True diversification requires non-correlated assets classes such as high quality fixed income to offset equity risk.
• Over the past few days, fixed income markets, particularly U.S. Treasury bonds held their ground, even appreciated in some cases, illustrating our view that a well diversified portfolio-even an aggressive one — must include a fixed income component.
• Equity markets function best with interim volatility. While extended bull markets may seem ideal, they often lead to “irrational exuberance” and can eventually trigger dramatic declines. Since 2002 we have had a long period of market appreciation. Market bounces and sell-offs are normal, and healthy market cycles provide an essential check on investor optimism.
Our Recommendations
• The most important decision an individual investor can make is to choose an asset allocation s/he can live with over the long term including during periods of decline. Long-term investors holding portfolios that are appropriately allocated given their financial planning needs and risk preferences should be prepared to withstand some bumps but are well positioned for the long run. Analysis shows and we agree that investors do better by choosing a lower risk allocation and sticking with it for the long run than by selecting a higher risk portfolio and selling equities to reduce risk in a downturn.
• During periods of market declines we proactively look for opportunities to harvest taxable losses in your portfolios. Whenever possible, we will sell securities to capture valuable losses and re-invest in similar securities to give you the opportunity to participate in the markets' eventual recovery.
Please rest assured that we are aware of the current situation and monitoring it. We approach a sell-off as a normal albeit unpleasant market condition — one which is required to achieve long-term growth.
As always, we are here to address any specific concerns or questions you may have.
Sincerely,
The Garnet Team
Garnet Group LLC
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Garnet Group is a Registered Investment Advisor with the Securities and Exchange Commission.
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