Many clients have seen an article published online which suggests the Dow Jones Index, a common measure for the performance of the U.S. stock market, could drop 4,000 points. Indeed, the first half of 2015 has certainly seen a lot of market volatility and minimal upside. As of market close on June 15, the S&P 500 has managed to eek out 1.24% and the Dow Jones Industrial Average is in the red, -0.18%.
*Chart Generated by http://www.finance.yahoo.com
The article referenced above focuses largely on the federal funds rate. The Federal Reserve Bank sets the federal funds rate, an interest rate at which banks can borrow money from one another through the federal reserve system. When inflation or economic growth are below target values, the Federal Reserve Bank reduces this rate, which makes it more attractive for companies to borrow to finance their expansionary projects and this consequently increases demand and output. When this rate is adjusted upward, the returns of the market tend to be more volatile.
The article proceeds to draw a number of parallels to the state of the markets in 1987, a year in which the Dow reached a high of 2,746 before retracing 41% to 1,616. Two similarities do exist, 1) the Dow Jones Index has recently reached all-time highs and 2) we (along with many other market participants) are anticipating the Federal Reserve Bank to increase the federal funds rate in the near future.
However, there are a few other points also worth noting. First, the recession that preceded the 1987 market crash saw a peak-to-trough GDP decline of only 2.7% whereas the 2008 recession was 4.3%. More importantly, the total return of the Dow Jones Index in 1987 was +0.6%. The correction in the market was short-lived and was followed by quick recovery and ultimate moves higher for equity markets.
It would not surprise us to see a market correction, which is typically defined as a 10% or more decline in the price of stocks, during 2015. However, like 1987, we anticipate that when the next correction occurs it may be followed by a quick recovery and ultimate move higher for the equity markets. This is, of course, our interpretation of the analysis we have performed on the market.
Also important to note, we expect near-term volatility to be greater in the equity market than in the bond markets, which are generally less volatile as measured by absolute standard deviation of total returns. By holding a diversified portfolio, consisting of both stocks and bonds, we strive to balance long-term expected returns with potential account volatility. We will continue to monitor market conditions and adjust portfolios when necessary. The most relevant message from our perspective is to maintain our disciplined approach to investing, which is the most proactive course of action.
Although no investing strategy can guarantee a particular rate of return or prevent against the loss of principal, we continue to advocate a diversified portfolio of assets, appropriate for your risk model.
Please note that the opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly. There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk. Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values may decline as interest rates rise and bonds are subject to availability and change in price.
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