I rarely take time away from the office (mostly because I love what I do so much and I’m what my family and friends affectionately refer to as a “workaholic”) but reflecting back on only the past 12 months (in which I’ve been away twice) I’ve noticed a very unfortunate correlation:

 

October 14th – 24th I’m away from the office for my honeymoon.

 

What happened while I was away? Only the worst market week to date (at that point) in the past 5 years. After more than 1,100 days, the long awaited market correction arrived on Wednesday, Oct 15th because of softer than expected economic data from Europe and China; weakness in commodity prices, particularly crude oil; fears of the spread of Ebola and a rapidly rising U.S. dollar.

 

January 8th – 15th I’m away from the office on the RBC Top Performers Cruise

 

What happened while I was away? Oh, lots. The price of oil took a wider turn for the worse dipping to new lows ($50 was the scary breaking point at the time), the BOC surprised us by lowering the overnight rate target by 25 basis points (bps) to 0.75%, the ECB finally unveiled the details of its QE program and the loonie slid dramatically reaching a near 6 year low (at the time) of 80 cents.

 

This Monday was the psychedelic moment of realization. Weeks ago I had booked myself a “me day” on the recommendation of a good friend who suggested that I needed a break. It was going to be awesome – I was going to go to the gym, sit in the steam room, get a massage, mani/pedi, the works.

Typical me, I came into the office to “check in” and do a few things before letting go for the day - next thing you know, North American markets plunged at the opening bell after China's main index sank 8.5% (its biggest drop since the early days of the 2008 global financial crisis) and the S&P/TSX fell 768 (or 5.7%) points while the Dow Jones industrial average fell more than 1,000 points. I’m sorry? …

 

Needless to say, I didn’t have my “me day” and the main conclusion I’ve drawn from all of this is that I am to never, ever be away from the office again – for everyone’s sake – and if I must be away, I will alert everyone with a mass email encouraging them to short the market for a week.

 

All jokes aside, this week was certainly a wild one and has reminded us yet again how important asset allocation, diversification and having a financial plan are – it has also reminded us that we cannot control nor time the market with any real certainty.

 

Most of you know the narrative by now: China’s economy is slowing. Lower commodity prices have a negative impact on the energy, materials and industrials sectors. They also foster concerns over global economic weakness. Many investors are worried that Fed tightening could cut into economic growth, bringing earnings growth and the stock market down with it. Emerging market risk perception has risen, with sell-offs having often come around the same time as Fed policy changes in the past.

 

I must have received and read market commentary from what feels like every analyst/economist/ portfolio manager on the street this week and while there are some differing views, a common tune everyone seems to be singing is what I also mentioned to you last week - that this is not a cycle ending bear market but rather a healthy pullback/correction with plenty of reasons to be optimistic.

 

So with that in mind, let’s focus on what you can control:
• Your savings rate
• Your asset allocation
• Self-awareness of your temperament

 

I’ve written to you about the first two many times before so today we’ll focus on the third bullet: temperament. From a temperament point of view, it is important for you as investors to realize that it’s normal for the stock market to sell off sharply and severely from time to time, and it’s also common for it to rally for long periods of time. The magnitude of these moves often defies expectations.

 

We have not experienced a bear market (20%+ pullback in the S&P 500) since March of 2009. During that timeframe investors indexed to the S&P 500 saw the value of their investments more than triple. Up until this past week, there had been only one period of double-digit losses in that timeframe – four years ago. The problematic aspect of this recent period of consistently high returns with few drawdowns is that it appears to have impacted our expectations and making us feel entitled to consistent gains.

 

This week has served as a reminder that it’s normal for the market to sell off from time to time, sometimes severely. Up until the 1980’s, it was common to experience a double-digit drawdown in the market every couple of years or so. Since then, drawdowns have been less frequent, but losses have tended to be more severe.

 

Losses can be painful, but with stocks, time usually bails you out. The problem is, we’re not programmed to think about it in such rational terms when we’re in the thick of it. We’ve evolved this way – but think of it this way: if you were to have saved $2,000 per year for the first 10 years of your working life starting in 1970, and upped it $2,000 annually at the end of each decade, you would have saved $230,000 through the end of 2013. Let’s also say you were a very poor market timer, only buying into the S&P 500 in lump sums shortly before the major bear markets of 1972, 1987, 2000, and 2007, but never selling. At retirement in 2013, that portfolio would still be worth $1.1 million. Time, regular savings and staying invested has proven over the years to offset even the poorest of market timing decisions.

 

Stocks have an excellent track record of building long-term wealth, offering average annualized rolling 30-year returns of 11.1%. However, investing in stocks and achieving these gains in the past has meant exposing oneself to the probability of suffering periodic severe losses and the feelings of regret that go along with them. While it can be hard to stomach the red screen when it flashes on your screen, if you have time on your side, days like Monday are rare opportunities to buy good quality businesses on sale. However, if you have less time, or a temperament where you cannot accept large losses (even if they are unrealized), you have to allocate less of your assets to equities and more to fixed income. Since 1926, intermediate-term government bonds have averaged a much lower 5.4% compound annualized return, but they never performed worse than -5.1% in any calendar year. They also tend to perform pretty well when the stock market is doing poorly, offering effective ballast in times of bear markets for equities.

 

Determining the proper asset mix is an important part of the investing process – and reviewing your plan, your tolerance and rebalancing when necessary is the key to staying on track – all things we do best as your trusted wealth management team.