In 2016, greater risks on a number of fronts are likely to increase the frequency and magnitude of volatility spikes for investors.
- Investors have had a shaky start to the year as worries about China, oil and the U.S. economy prompted a global stock market selloff.
- The 65% decline in oil prices over the past 18 months is largely due to overproduction and while low oil prices are certainly a drag on investment and energy-linked employment in the U.S., low oil prices alone do not have the ability to pull the U.S. into recession.
- Oil price declines have heightened investor awareness to default risk; penalizing countries, sectors and companies with low-quality balance sheets. Quality will likely be a major factor in equity performance in 2016.
- Chinese stocks had a brutal first week of the year, with the Shanghai composite falling by 10% overall. The truth is that Chinese markets do not appear to be mature enough to weather a change in exchange rate policy without severe volatility.
- China is growing more slowly, but this is nothing new. While also volatility-producing, it has little to do with underlying economic conditions or company fundamentals, and the U.S. is relatively well insulated from a slowing China.
- U.S. employment is growing strongly, with 292,000 non-farm payroll jobs added in December. The reality is that, while a continued inventory correction could reduce 4th quarter GDP to close to 1% growth, real GDP still looks likely to increase by between 2% to 2.5% over the course of 2016.
- Americans are very comfortable with cash. Using year-over-year core CPI as an inflation measure and the federal funds rate as a cash yield, the real return on cash today is in the region of -1.6% per year, far below the positive 1.8% real yield in cash balances in the 50 years before the onset of the financial crisis.
- Americans, however, remain very nervous about stocks. Last year, they withdrew approximately $160 billion from U.S. equity mutual funds, despite the fact that U.S. stocks have provided an annual average total return of over 11% since 1950.
Overall, the U.S. economy is not booming, profits are not soaring and Chinese is not out of the woods. However, given still extraordinarily low cash yields and slow but steady growth in the global economy, the start-of-the-year selloff reflected fear more than fundamentals. In the long run, fundamentals should prevail. Investors should be cautious, but should not panic.
Tips for Dealing with Market Volatility in Year 2016
- Set aside cash for short-term goals. Have a sound cash flow plan for short-term, intermediate-term and long-term which will give you better perspectives on when and how much you need to withdraw from your diversified portfolio. When you have adequate savings for emergency funds, and conservative investments to meet your cash needs for next three to five years, you are less likely to make emotional mistakes by selling your long term equity investments during market downturns like this one.
- Ignore market noise. In the short term, market price levels move in cycles, fluctuating with the collective greed and fear of market participants. When a correction does occur, it will not last. You don't want to risk forgoing the opportunity of achieving a long-term real return on your funds while waiting around for a possible short-term correction.
- Focus on your long term goals. Successful investing requires focusing on the long term. Remember that your long-term portfolio contains funds you'll use over the rest of your life. Long-term market movements are driven by fundamentals such as growth in earnings of listed companies. Over the long term the trend of markets has been up despite various market cycles. The chart (Source: JP Morgan) shows S&P 500 index growth since year 1900.
- Work with a competent and unbiased financial advisor to design a portfolio that fits your risk number and required rate of return to help you achieve your financial goals. When you feel uneasy about the negative headline news, you have someone to talk to in order to remind you why you have a customized financial plan in place and follow a disciplined investment strategy during the tough times.
- Simplify your financial life. Make investing simple for yourself so that your savings can go into your portfolio continuously, such as contributing to your 401(k) plan through payroll deductions and having an automatic investment plan to transfer a fixed amount from checking to be invested monthly.
- Focus on the things you can control such as setting a family budget. It’s vital that you figure out how much you’re spending, and on what. For most of us, a significant amount is wasted on impulse purchases, avoidable fees, poor planning and inappropriate use of debt. To get a good handle on what you are spending, consider using a software program like Quicken to help you track expenses against your monthly budget. This way, you are more likely to spend money based on your values.
About Echo Wealth Management, LLC
Echo Wealth Management is an independent, focused wealth management firm located in Plymouth, Minnesota that takes the complexity out of wealth management. This firm is a Registered Investment Advisor in the State of Minnesota. This firm offers integrated, comprehensive strategies to clients range from executives planning a secure retirement, to families looking to preserve their assets for future generations, to businesses seeking expert investment advice. For more information, visit http://www.echowealthmanagement.com.