One of the most painful, but important, lessons that many investors took away from the worldwide financial crisis of 2008 is that what goes up can also come back down. Volatility in the first quarter of 2016 has also helped to reinforce the impact of that reality.
For example, on March 1, 2016, the major U.S. stock indices moved upward after weeks of disappointment, with the Dow climbing 2.1 percent and the S&P 500 gaining 2.4 percent, although the gains did not make up for earlier losses, with both still -3.2 percent YTD. The current conditions are causing many investors to have terrifying flashbacks to 2008 and bringing about a growing sense of dread, but market movements should be expected and shouldn’t automatically cause investor panic.
Sure, the glut in energy supply and resultant low prices are having a ripple effect throughout the economy, but that can be both positive and negative, depending on your perspective. Cheaper oil gives consumers more money in their pockets to purchase other goods, which can benefit other sectors, but since almost everyone with a well-diversified portfolio has some exposure to energy stocks in their retirement portfolios, consumers are seeing reduced value in their 401(k) accounts.
The fear for many is that the collapse in energy indicates a replay of when the housing bubble burst. Admittedly, there are some similarities, but the two cases are not really the same. While it is certainly possible that the energy situation could continue to pull the markets down, by collaterally damaging some of the largest banks which have significant loan exposure to energy companies. The good news, though, is that there are not hundreds of billions’ worth of derivatives based on the energy market. Much more damage was caused by the collapse of the derivatives market than by the actual bursting of the housing bubble.
One concern, however, about the current energy-driven volatility is that it may be blinding some investors to the fact that all the old rules no longer apply. We appear to be facing a new economic reality that bears some similarities to the past, but in many ways represents a much different world than the one we faced eight years ago. For the last 100 years, the S&P 500 averaged an annual return approaching 10 percent and for the last 30, bonds have been giving investors more than 8 percent, but such expectations are no longer realistic.
There is still growth in the developing world, but it has slowed, something largely attributable to the decline in interest rates around the world. Growth in the U.S., Europe and Japan has slowed to less than 2.5 percent, but so has inflation, which is also declining throughout the developing world, including China.
The reality is conditions have changed, and like it or not, we are now living in a scaled-down world. We may moan about how returns and growth are lower than we have become accustomed to and certainly lower than most of us would like, but so are inflation and costs. When all factors are taken into consideration, that means there are opportunities out there for investors to earn acceptable real returns.
The investment world will always have much uncertainty about it, and it’s always possible that at some point we’ll see returns climb back to previous levels, but it would be imprudent to expect that anytime soon. Most investors would be better off to accept lower relative returns than in taking on unnecessary risk in order to chase outsized returns that just might not be there.