Market turbulence is never pleasant, but we know it is something to be expected.
The 3% drop for U.S. stocks yesterday was the worst single-day move this year, but it can’t really be considered a rarity. In the last 100 years, stocks have fallen 3% more than 300 times. Stocks simply go through tumultuous periods on a fairly frequent basis.
Pundits try to attribute causes for market slides retrospectively, and in this instance, the suspects are signs of global weakness, trade tensions with China and the “inversion” of the yield curve. All raise concerns regarding the economy, but none provides an absolute signal of what lies ahead.
The “yield curve inversion” is a fancy way of saying U.S. Government bonds now offer lower yields for longer maturities than shorter maturities (e.g. a 10-year bond is yielding 1.56% compared to a 1-year bond yield of 1.75%). Historically that has been a bad sign for the economy, as a recession has generally followed (but not immediately). From an investment perspective, however, it doesn’t give us much useful information.
History shows that stocks have generally risen after an inverted yield curve. Sometimes the market has dipped in the short term, but stocks were higher one year after each of the past five inversion situations in the U.S. (with an average gain of more than 13% for the S&P 500). The past is not a template for the future, but on average, the market tends to head upward.
Whether or not stocks continue to climb in the near-term, here are some points to remember:
- Your investment portfolio is structured around your time horizon and risk tolerance.
- Despite low yields, an allocation to high credit quality bonds remains one of the best ways to counteract risk in stocks.
- Regular rebalancing is a way to take advantage of choppy markets by reducing stocks when prices are up and buying when prices are down, knowing that the long-term trend is generally higher.
We don’t have a crystal ball, but we do have time-tested ways of dealing with uncertainty.