Market Corrections

On March 11th, the Dow Jones Industrial Average (DJIA) closed at a record high level of 14,447. It was the fifth straight trading day of record highs, which started on March 5th when the market closed at 14,253. This surges past the previous record close of 14,164, set on October 9, 2007. However, rather than celebrating the improved economic landscape, much of the financial media has already redirected its attention to the timing of the next market correction.

Justified Valuations

Record levels in the equity markets do not necessarily translate to inflated valuations. We invest in stocks because history tells us that stock prices rise over the long-term; as such, the market expectation should be to regularly reach record highs. And while it’s been over five years since we last reached record levels, this is an anomaly as we’ve reached new highs in 36 of the last 62 calendar years.

According to the forward price-to-earnings (P/E) ratio on the S&P 500 Index, equity markets remain fairly valued, if not undervalued, relative to their long-run averages. Second, the dividend yield on the index is higher than the 10-year Treasury yield, which remains near all-time lows.

Precious Metals Not So Precious

Market corrections are not out of the ordinary. Since 1946, the market has experienced an average peak-to-trough decline each year of approximately 14%. However, some investors believe they can use precious metal investments to strategically dampen the impacts of a market correction on their overall portfolio. What is important to remember is that buying precious metals is pure speculation, not investing: you bet and hope the price will go up, but have no real reason to expect it. To expand on this last point, only projected earnings can generate an expected return. Since gold neither pays a dividend nor generates cash flow, there is no basis for expecting a future return.

In 1980, gold was selling at $850 per ounce. If gold exhibited a return consistent with inflation, the price of gold would have grown from $850 to $2,400 per ounce. At today’s level of approximately $1,600, gold has lost about a third of its real value over the last thirty-three years. During the same period, the S&P 500 has risen nearly 14 times in nominal terms (from 111 to 1,550), and therefore increased its real value well in excess of 10 times (and even this completely ignores dividends). Attempting to dampen downturns through precious metal speculation may have severe consequences on an investor’s ability to reach long-term financial goals.

Stay the Course, in Good Times, Too

We have no way of knowing when corrections will begin or when they will end. Intelligent-sounding predictions about the economy and the market are as plentiful today as they have always been. However, history tells us these predictions are merely for entertainment value, not meant to serve as a basis for prudent investment decisions. Peter Lynch, the former head of Fidelity’s famous Magellan Fund, offers us this reminder: “Far more money has been lost by investors preparing for corrections or trying to anticipate corrections than has been lost in the corrections themselves.”

This is why we continue to reinforce to clients the importance of a long-term, disciplined investment strategy. By focusing on the big picture, rather than making emotional decisions during the individual ups and downs of the market, investors are better able to absorb the downturns and enjoy the upswings.