Is it Still Safe to Invest in Stocks?

Many investors are beginning to wonder whether the current market rally is coming to an end.   For some, the concern is that the market is cyclical and we are in the seventh year of the current market rally.  Others look to valuation and fear that the current market is trading in the upper end of traditional valuation ranges.  So, how does an investor protect themselves in such times?

To answer this question, let’s first take a look at some facts.  After bottoming in March of 2009, the U.S. stock market has staged an impressive rally.  For simplicity, if we use March 2009 as a start date and March 2015 as our end date, we find that the S&P 500 has provided investors an average annual return of 19.7% during this six-year period.  If we look at a 10 year period ending March of 2015, encompassing a more complete market cycle, the S&P 500 has generated returns of 8.0%, more in line with long term historical averages.

An investor with a short-term time horizon is likely focusing on how the market has behaved over the past six years and feel that we are indeed due for a correction.  Investors who have a much longer term time horizon are more likely looking at the market’s 10 year average and are not overly concerned.

Valuation statistics can also be easily manipulated to suggest that the market is undervalued, fairly valued and even overvalued.  Moreover, the timeline used when evaluating these statistics can have a major impact on one’s conclusions.

It is no secret that Sigma believes that we are still in a secular bull market.  Wikipedia suggests that secular bull markets can last from 5 to 25 years.  However, within this time period, the market can also experience corrections which are much shorter in duration.  During these periods of market corrections, it would not be surprising to see the market fall by a magnitude of 5% to 10%, or even more.  We would argue that these cyclical declines are quite normal and healthy to sustain the positive secular trend.

Armed with this knowledge, some investors may attempt to time the market and sell stocks during these cyclical down periods, hoping to buy back into the market at lower prices so they can participate in the positive longer-term trend.   While on paper this seems like a winning strategy, through academic studies and personal experiences, we believe that it is nearly impossible to consistently know when to sell and when to buy back.  If you get out of sync with the market’s fluctuations, your investment performance is likely to suffer greatly.

Instead, Sigma recommends that investors maintain a consistent asset allocation strategy.  During periods of market strength, equities will be over-weighted in the portfolio and a small amount of equities should be sold.  As the market subsides, the equity allocation will be slightly below target, affording investors the opportunity to buy back in.  By taking the emotion out of the decision making process, and letting your strategy tell you when to make these incremental changes, we believe investors have the best chance for success.

All comments and suggestions are welcome.

Christopher J. Kress, CFA®