2016's Markets Taught Valuable Lessons
January 24, 2017 | Your Finances
Who can forget the harrowing start to the markets last year that saw a plunge of 13 percent in the first 20 days of January? China debt fears, global deflation, secular stagnation worries, Brexit and U.S. election surprises were the dominant headlines of 2016. Not surprisingly, given that long and gloomy list of variables, investor sentiment was morbid for much of 2016. In fact, according to the American Association of Individual Investors,1 the percentage of investors who said they were bullish about the stock market fell to below 20 percent in four different weeks last year.
To put this in context, since July 1987, there have been only 27 other sub-20 percent readings out of a total of 1,536 observations. Even in the depths of the 2008-2009 Great Recession, there were only two such readings; the low of 18.92 percent on March 5, 2009, was registered a mere four days before the market bottomed.2
What was the reaction of investors to these events? In many cases, pessimistic investors sold, abandoning equities in favor of a fear-based reaction to what just happened. Indeed, for much of 2016 total equity mutual fund and exchange-traded fund flows were negative, while their bond counterparts attracted cash inflows. In a surprise to most investors, this all changed after the U.S. presidential election. After the nearly 800-point decline in futures as the election results filtered in, stocks began to rally, while bonds returns turned negative. Once again reactionary investors were forced to play catch-up as they reversed course and quickly bought stocks and sold bonds. Needless to say, this is not a recommended path to robust, long-term performance.
While professional investors often get hired or fired based on their performance versus a benchmark, the reality is that these numbers are often peanuts compared to the overall big-picture, long-term value they can add. For example, given the above volatility and pessimism, it is not hard to imagine that many individual investors missed the entirety of the fourth-quarter rally that pushed U.S. equities to record highs. Looking through a longer-term lens, it’s not hard to fathom that many also missed much of the post-Great Recession rally.
While much airtime is spent discussing the day-to-day movement and prospects for individual markets, the most impactful decision an investor needs to make is to commit to a long-term portfolio that matches his or her risk and return requirements. While this allocation is not set in stone and should be tweaked throughout one’s life as markets and individual circumstances change, it should serve as a long-term anchor for that individual’s portfolio. To give a real-life example, if one were to drive from Milwaukee to Chicago often, he or she would have a planned route. However, construction, accidents and traffic may be reasons to deviate from this plan occasionally. Similarly, investors should have a long-term plan mapped out that will serve as the guide for portfolio allocations.
Many investors find the steadying hand of a financial professional worth the additional cost when it comes to sticking to their plan. An advisor with experience in different markets can not only help establish a solid asset allocation strategy and diversified portfolio, but also help an investor avoid making reactionary decisions based on short-term market movements or events or allowing their political beliefs to drive their portfolio. Multiple studies have demonstrated that a financial advisor is likely to improve your returns as well. A 2014 Vanguard study, Putting a Value on Your Value: Quantifying Vanguard Advisor Alpha,3 comes to mind. This study showed that financial advisors can potentially add about 3 percent in net returns for their clients.
2017: The Road Ahead
Investors have become more optimistic in 2017 just as the economy firms and a potentially pro-business administration takes office. We continue to believe that the underlying economic fundamentals point to ongoing growth in both the U.S. and abroad in 2017. As conditions and confidence improve, investors may again be compelled to make large changes to their portfolios and chase recent performance. Investors who aren’t certain of their ability to stick with their asset allocation may want to seek counsel from an experienced financial professional.
With the experience and perspective to calm fears and ensure that a portfolio built around a specific time horizon, risk tolerance and objective stays the course, advisors can help investors reach long-term goals that may be unattainable if they’re going it alone. The new year presents an opportunity to seek advice to solidify a financial and investment plan and avoid the mistakes of the past.
1. American Association of Individual Investors Investor Sentiment Survey, 2016.
2. American Association of Individual Investors Investor Sentiment Survey, 2016.
3. Vanguard calculations, based on data from Thomson Reuters Datastream.
Northwestern Mutual is the marketing name for The Northwestern Mutual Life Insurance Company, Milwaukee, WI (NM) (life and disability insurance, annuities, and life insurance with long-term care benefits) and its subsidiaries. Northwestern Mutual Investment Services, LLC (securities), subsidiary of NM, broker-dealer, registered investment adviser, member FINRA and SIPC. Northwestern Mutual Wealth Management Company® (NMWMC), Milwaukee, WI (fiduciary and fee-based financial planning services), subsidiary of NM, limited purpose federal savings bank.
This publication is not intended as legal or tax advice. Financial Representatives do not give legal or tax advice. Taxpayers should seek advice based on their particular circumstances from an independent tax advisor.
The opinions expressed are those of Northwestern Mutual as of the date stated on this publication and are subject to change. There is no guarantee that any forecasts made will come to pass. This material does not constitute investment advice and is not intended as an endorsement of any specific investment or security. Information and opinions are derived from proprietary and non-proprietary sources. Sources may include Bloomberg, Morningstar, FactSet and Standard & Poor’s.
Please remember that all investments carry some level of risk, including the potential loss of principal invested. Returns represent past performance, are not a guarantee of future performance and are not indicative of any specific investment. Diversification and strategic asset allocation do not assure profit or protect against loss. Although stocks have historically outperformed bonds, they also have historically been more volatile. Investors should carefully consider their ability to invest during volatile periods in the market.