Last week the markets closed the month of February with every major US index down slightly. While the S&P 500 is still positive for the year, it’s been two months of fits and starts. We’ve had three great years in the market, and many investors are starting to worry.
If we look at long term averages, sometime in the next two to three years we are due for the market to decline about 20%. On average, bull, or positive, markets last about four years. 2026 would be year four of our current run. And on average bear, or negative, markets last about a year.
If you’re a scientist or engineer, you might say it’s a regression to the mean. We’re going to have a year that brings the market closer to its long-term average. To use baseball as an analogy, if a batter is hitting .330 this season and struck out his last two at-bats, you would say he’s due for a hit, because he hits the ball about one out of every three times he comes to bat. In plain English, we’re due for a down market.
This does not mean you should sell everything and wait in cash until the decline hits. First, we don’t know exactly when the market will decline. And then we don’t know when it will recover. And while I don’t have any guarantees, I expect this next decline will be closer to the average, and not like the 2008-09 financial crisis.
That was a balance sheet recession, when companies prioritize paying down debt after a bubble bursts. It’s an “over” recession. Companies and families are over-leveraged: they have too much debt. Investors were over-enthusiastic: they chased high returns in riskier assets. Companies were over-staffed and over-spending: high revenues meant not as much attention was paid to keeping expenses in check. When the bubble burst, corporations and families had to dramatically cut costs, slashing jobs and spending, to pay down their debt, and realign their balance sheets.
Think about the housing market as an example. People purchased homes that dramatically increased in value, creating a bubble. Families borrowed against the equity in their homes, and when the value dropped and the equity disappeared, so did their net worth.
There’s a debate right now over how leveraged corporate America really is, and how much of a bubble we’re seeing in the market. Which means a bear market is probably coming. The best thing you can do is to make sure your portfolio is aligned with your goals and the risk you’re taking is aligned with your timelines.
Your action item this week is to go to bed a little earlier, so that the loss of an hour as we spring forward next weekend doesn't hurt quite as much.
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