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January was a tough month for most investors. At one point during the month the S&P 500 index was down more than nine percent since the beginning of the year. Even after a rally over the last third of the month, the index finished the month down more than five percent. And volatility was very high – the S&P moved by more than one percent on 13 of the 19 trading days in January.
So what happened? First of all, the market was not exactly rock solid going into the new year. As we pointed out last month, while the S&P 500 was essentially flat for 2015, a number of the broader indices posted losses. Then news from China roiled the markets in the rest of the world, first with big declines in the Chinese stock market and then with a string of announcements of weaker economic results. The latter news pushed oil and commodity prices down again and raised fears of a recession in the U.S. and other developed economies.
The concerns about recession were further stoked by pundits who proclaimed that previous recessions had almost always been preceded by stock market declines. Of course, this reasoning becomes circular: fears of recession push the stock market down and then the market being down raises fears of recession. While many recessions have been preceded by market drops, many market declines have not foreshadowed recessions. As the Nobel Prize winning economist, Paul Samuelson, once said: “The stock market has called nine of the last five recessions.”
So where does the market go from here? Of course, we don’t know. But we do think the gloom and doom is overdone. Stock market lore says that if the market declines in January, it will be down for the full year. You only need to look back to 2009 to see that this is not always true. The S&P was down 8.6% in January 2009 but up more than 23% for the full year. Similarly, in 2003 the S&P500 was down 8.6% in January 2009 but up more than 23% for the full year. Similarly, in the S&P dropped 2.6% in January but gained more than 26% for the year. We’re not predicting that the market will gain more than 20% this year – we’re just saying that you can’t rely on the “January indicator.”
Fears of a recession and related concerns about problems in China spreading to the U.S. also seem overdone to us. While the U.S. economy may not be going gangbusters right now, many key indicators show continued modest strength.
On the other hand, the Chinese domestic economy is likely to remain rocky for some time. The Chinese government is trying to shift the economy from being driven by infrastructure spending (think bridges to nowhere and empty high-rise buildings) to a consumer driven economy. That strategy probably makes sense, but it will take a long time and will not progress in a straight line. Meanwhile, changes in Chinese demand will continue to dominate the world commodity and metals markets. But all of that said, we expect the effect on the rest of the U.S. economy to be very modest.
Finally, how should recent volatility affect your investment strategy? That is the easiest question to answer: not at all. As we have said many times before, no one can predict where the market is going, and those who try to time the market are likely to get “whipsawed.” This means that investors who get spooked and bail out of the market usually sell just as stocks are bottoming. Then they miss the rebound before finally gathering up enough courage to get back into the market just as it is peaking again. Keep as much money in stocks as you are comfortable with for the long haul and ignore short-term market gyrations like we’ve seen in January. Well, maybe not totally ignore them – January’s volatility appears to have created some interesting bargains that could be worth adding to your portfolio.