Fellow investors, it may be time to pay our respects to what's been a nearly seven-year bull market.
There's little escaping the carnage
Despite a substantial rebound from its intraday lows on Wednesday, all three major U.S. indexes are continuing to drift lower in what's been a nightmarish start to 2016. Through Wednesday's close, the Dow Jones Industrial Average, S&P 500 (^GSPC 1.73%), and Nasdaq Composite were off 9.5%, 9%, and 10.7%, respectively, year-to-date. These three iconic indexes are also down by 14.1%, 12.9%, and 14.5%, respectively, from their all-time highs set last year through Wednesday.
Energy has obviously been a big issue. Crude oil prices are down around 75% in a year-and-a-half, calling into question the sustainability of small- and mid-sized U.S. shale producers in the United States. Another issue has been slowing growth in China, which is hampering demand for commodities and worrying investors who've counted on China's growth to counteract weakness in Europe and other parts of the world.
But putting these well-documented macroeconomic issues aside, this isn't just limited to oil and commodity stocks. Some megacap companies are officially in bear market territory now -- defined as a drop of 20% or more from a recent high -- and certain sectors/industries have nosedived.
Take technology giant Apple for instance. Shares of the $537 billion giant closed below $97 on Wednesday after tipping the scales at $134.54 on an intraday basis in 2015. This equates to a drop of 28%, clearly placing Apple in bear market territory. Oil giant ExxonMobil, the fourth-largest publicly traded company in the U.S., is down 22%. Even Warren Buffett's conglomerate Berkshire Hathaway is bordering on bear market territory with a decline of more than 17% from its all-time high.
Select sectors have also been nightmares. Biotechnology has been among the hardest hit, with the SPDR S&P Biotech ETF down 21.5% year-to-date, and off nearly 40% from its 52-week high. A quick scan of the 359 publicly traded biotech companies shows that a mere 14 are up year-to-date.
In sum, our bull market may be running on fumes; but as you'll see below, that's really not a bad thing.
Three things to do right now to protect your portfolio
The early year action may very well have you reconsidering whether you want to remain invested in stocks or if you'd rather pull your money out and stick it under the mattress. Personally, I consider the latter to be the worst idea possible, and we'll get to why that's the case in just a moment.
If you want to protect wealth over the long-term, I'd consider implementing the three "R's" right now: Relax, Reassess, and Reinvest.
First of all, relax! Stock market corrections and stock market "crashes" are actually far more common than you might believe. There have been 34 corrections of 10% or more since 1950 in the broad-based S&P 500, meaning we see one about once every two years. Furthermore, based on data from Yardeni Research on corrections dating back to 1950 in the S&P 500, we're almost three times more likely to be in a bull market than in a bear market. Bear markets and stock market corrections tend to happen quickly, whereas bull markets often develop over years.
Adding to the above point, of the 34 corrections in the S&P 500 since 1950, not including our ongoing correction, all have eventually been completely erased by bull markets. That's 34 out of 34 moves lower of 10% or more being put in the rearview mirror at some point in the future, whether it takes weeks, months, or years to happen. That's a resounding victory for long-term, optimistic investors.
Given these points, it's just not worth getting in a big fuss over a stock market correction unless you'll need your invested money sometimes in the next three years.
Just because time is on the side of the buy-and-hold investor doesn't mean that it's not a good idea to reevaluate the holdings in your portfolio. However, when doing so it's important to differentiate whether a stock you're holding is experiencing temporary weakness or if a systemic change has occurred in its business model. If the latter is true, it could be time to remove that stock from your portfolio.
Let's take two examples from my own portfolio. Bank of America (BAC 1.09%) has been one of my larger holdings for the past four years, and despite being up well over 200% at one point I chose not to sell. Why? The investing thesis still seems to be intact. Legal expenses are being put in the rearview mirror, and the potential for rising lending rates over the long run should allow for its net interest margin to expand. Compared to its peers, Bank of America still looks very attractive despite the exposure it may have to energy loans. Thus, it's a portfolio holding that I may wind up adding to.
On the flipside, one of my much smaller holdings has been a veritable nightmare: Seadrill (SDRL). Contracted offshore deepwater drillers likely need $50+ per barrel oil prices for production to be worthwhile for larger exploration and production companies, and crude is at nearly half of that value. Seadrill has strong cash flow through 2016 thanks to a handful of long-term contracts, but it could be staring down numerous idle rigs in 2017 and beyond. Because of Seadrill's large debt load, this could be a situation where the business model may no longer be viable. Despite being a small position, it may be an investment I take my lumps from and walk away.
Finally, consider reinvesting in companies whose business models are still solid after reassessment, and which have fallen during this recent correction.
How do you know when it's time to buy? Here's the interesting part: you'll actually never know, since timing the market with any accuracy over the long run just isn't possible. The best thing you can do for your nest egg is to regularly buy stocks regardless of what the stock market is doing. Adding money regularly provides two important benefits.
First, regularly buying stocks can help you cost average down on solid businesses during a bear market, stock market correction, or stock crash. Remember, stock market corrections can be influenced just as much by fear and emotion as actual fundamental and macro reasons, meaning that you have an opportunity to buy into solid businesses at possible bargains.
But more importantly, because you can't correctly time the market you run the danger of missing out on its top-performing days. True, you could also miss some of its worst days too, but figuring out which days those will be with any accuracy would require a time machine.
Research from analysts at J.P. Morgan Asset Management showed that investors who bought and held the S&P 500 index between Dec. 31, 1993 and Dec. 31, 2013 -- that's through the dot-com bubble and Great Recession -- would have earned returns of more than 480%. If you missed just the 10 best trading days over an approximate 5,000-day stretch your return dropped to 191%. Miss the 40 best trading days, or less than 1% of all trading days in this 20-year period, and your total return was negative.
This data is a very powerful reminder that staying the course is your best possible strategy for surviving a possible bear market.