The Dow Jones Industrial Average dropped nearly 400 points (3%-plus) today, which was attributed to a bad unemployment report -- the unemployment rate climbed higher than it has in 22 years -- and (yet another) rise in oil prices.
The Dow is at best an imperfect measure of the market at large -- at worst, it's an irrelevant measure. Still, it's a symbolic and psychologically important index made up of the bluest of U.S. blue chips -- McDonald's (NYSE: MCD ) , Johnson & Johnson (NYSE: JNJ ) , and Coca-Cola (NYSE: KO ) among them.
After topping the 14,000 mark last October, the Dow now sits around 12,300. What should investors make of the drop? Where is the market headed from here? I put these questions to a panel of Motley Fool analysts.
1. Near the end of May, Warren Buffett was quoted as saying that the U.S. recession will "be deeper and last longer than many think." Have you seen anything that would contradict Buffett's outlook? Should investors alter their investing strategies based on the macro-level outlook?
Andy Cross, co-advisor, Motley Fool Income Investor: I wrote the other day that famed mutual fund manager Peter Lynch used to spend just an hour or so focused on macro economic issues. And he did pretty well over his investing career.
Historically, U.S. recessions last less than a year, while your typical expansion goes on for years. So rather than worry about today’s employment report or what GDP growth will be next quarter, focus on owning, and buying, the companies that are best situated to create wealth for you over years, not just months. These can be large-cap innovators, like Apple (Nasdaq: AAPL ) , or wide-moat dividend-payers like Paychex (Nasdaq: PAYX ) . Both are high-quality companies that will stand up straight through good times and bad.
Bill Barker, senior analyst, Hidden Gems Pay Dirt: Well, a recession (let’s not upgrade it to the recession until we’re sure we’re in one) would have to be deeper and longer than many think because a whole lot of people don’t think the economy will actually quite reach one. Maybe that’s all semantics, I’m not sure. But the big “R” word carries a lot of weight, so it’s worth at least remembering that there are some hairs to split.
The larger question is whether there’s enough evidence to expect something worse than a short-maybe-quasi-recessionish-slowdown that starts turning around sometime in the second half of this year. In certain sectors, absolutely. Real estate, which is one-third of the three-legged Housing-Oil-Credit Beast that’s the central worry -- well, if that turns around by the second half of this year, that’ll be the shortest real-estate downturn on record. I’d be very cautious about betting on anything that’s reliant on the housing market if you don’t have at least a three-to-five-year time horizon.
But that doesn’t mean that you should alter your investing strategy based on my, or anybody else’s, macro outlook. It’s a good reminder that every investment should be undertaken with a minimum three-to-five-year time horizon. Don’t buy anything, housing, oil, whatever, without factoring in much more than the next half-economic cycle, because that’s a great way to lose money in the market.
Robert Brokamp, advisor, Motley Fool Rule Your Retirement: No. In fact, given that more than two-thirds of the economy is driven by the consumer, and the consumer is getting pinched from all sides, I'd tend to agree with him. But did Buffett follow his prognostication with "So we've decided to sell all our stocks and companies, and sit on cash until the recession is over"? Nope. That's because he knows that the market is a leading indicator; by the time the economy turns back up, the market will have already recovered. Be like Buffett and hold on.
2. Nearly every major market index is down this year. Even worse for long-term investors, over the past decade (an admittedly turbulent time for stock investors), the Vanguard Total Bond Market Index actually outperformed the Vanguard 500 Index Fund -- by better than a percentage point per year. Are we headed toward Dow 10,000 levels? What do you expect from the market from this point forward?
Cross: If I could predict where the market will be in a year or so, I would shut off my computer and head to Vegas and the roulette tables. And I hate roulette. I don’t know if the Dow will be at 10,000 by Christmas. I don’t know if it will be at 10,000 by next summer. But from these levels, which relative to earnings are far more reasonable than they were at the end of the last decade, I’m pretty confident that U.S. stocks will outperform bonds over the long term. If you have three to five years to invest, you need to be in stocks -- both U.S. and international ones.
Barker: I expect the stock market to return something approaching 6.5% returns in real terms (i.e., after subtracting the rate of inflation) over the next 20 years -- which is about the right time horizon for me, as that gets me within a decade or so of retirement.
That’s nothing more or less than expecting the normal returns that the stock market has returned over almost any longer-term horizon: 50, 100, 200 years -- whatever you want. It’s known in some corners as “Siegel’s Constant,” based on the work of Wharton professor Jeremy Siegel, who documented the remarkable consistency of real returns to come out at that level over almost any lengthy time period.
The last 10 years of essentially zero returns in the market just make slightly outperforming that level a little bit more likely going forward, but they don’t make returns going forward much better than that.
Don’t ask me about a time period much shorter than the next 20 years. I’ve got little insight on that. Dow 10,000? Maybe. I hope so. I’m a net buyer of stocks over the next 20 years, so logically I’m hoping for better prices.
Brokamp: I don't think too much about the Dow since it's a quirky price-weighted index (which means that a stock that trades at $50 a share has twice as much influence as one that trades as $25 a share -- regardless of the companies' market caps). But I will point out that the dividend yield on the S&P 500 is above 2% for the first time since the mid-1990s, which means it's gradually becoming a better value. At some point, home prices and the dollar will stop dropping, and once again U.S. stocks will become investors' favorite flavor. I don't think that will happen in the next year or two, but I'm also not selling all my stocks in an attempt to time the market. My 401(k) contributions now buy more shares, as do my (higher) reinvested dividends. I'm confident it'll pay off in the long term.
3. What's the single most important lesson to take away from this volatile market?
Cross: Don’t lose sight of why you buy stocks in the first place. Hopefully you’re not trying to pick up a few points here and there before trying to time a peak and get out. Rather, focus on owning businesses that are creating sustainable value for their shareholders. And keep in mind that regardless of what the stock price is doing over the course of a month, the company value is growing. In the end, you’ll see the payoff, as long as you learn to navigate the bumps in the road.
Barker: Diversification, as always. Don’t have your portfolio concentrated in a few stocks, or just stocks (you should have exposure to bonds, commodities, real estate, etc.). And you should have some international holdings.
If you’re nearing retirement, you should be increasing your bond holdings -- the usual things. There’s nothing at all about this market that is remarkable. It’s just a reminder of lessons that have been well-documented for decades.
Brokamp: You cannot rely on one type of asset category to pull you through. While the S&P 500-tracking SPDRs (NYSE: SPY ) is down more than 5% this year, international stocks such as the iShares MSCI EAFE Index (AMEX: EFA ) and the Vanguard Emerging Markets Stock are down just 2.5% and 1.3%, respectively. The DJ Wilshire REIT exchange-traded fund is up a total of 10.9% year-to-date. Since 1972, large-cap American stocks (as represented by the S&P 500) have been the top-returning asset class in just four years. So every investor should own all kinds of stocks, from all parts of the world.
Brian Richards owns shares of the Vanguard 500 index. Andy Cross owns shares of Johnson & Johnson. Bill Barker owns shares of the iShares MSCI EAFE Index. Robert Brokamp owns none of the companies mentioned here. Coca-Cola is an Inside Value selection. Johnson & Johnson is an Income Investor pick. Apple is a Stock Advisor recommendation. The Motley Fool owns shares of SPDRs. The Motley Fool has a disclosure policy.