Big slump is no cause to ditch stock market

After more than five years of stock market gains, investors could be forgiven for worrying that big sell-offs may be the harbingers of bigger slumps.

But, even as stocks were plunging last week, strategists and professional investors were telling their clients that the volatility was no reason to abandon the market.

Worries about a slowdown in global growth drove oil prices and global stock indices sharply lower. Headlines about the spread of Ebola and the deepening conflict with Islamic State fighters in the Middle East also turned investors cautious.

Still, many investment strategists pointed out that the key factors supporting stocks during their current bull run market remain in place. The U.S. economy is still growing, and so are corporate earnings.

Most strategists say investors should take advantage of the opportunities that come with a stock sell-off.

Last Wednesday, the Standard & Poor's 500 stock index dropped as much as 7.4 percent from a recent record. Investors fled to the relative safety of bonds, pushing up their prices and dropping the yield on the 10-year Treasury note to its lowest level in more than a year.

Erik Davidson, deputy chief investment officer for Wells Fargo Private Bank, says that big shifts in financial markets are a good time to change, or rebalance, the proportion of stocks and bonds held by investors.

Since the financial crisis and the Great Recession, many investors have allocated too much of their portfolios to bonds, and shied away from stocks, Davidson says.

That strategy has served them well over the last seven years, as bonds have rallied. The Barclays aggregate, a broad index of bonds, handed investors positive returns every year since the financial crisis, with the exception of 2013 when it gave investors a 2 percent loss.

The time may now have come to put more money into stocks. Bonds could slump if the economy continues to improve and interest rates start to rise from record lows.

“We are suggesting that investors who have been on the sidelines use this as an opportunity to get into the (stock) market,” Davidson says.

The yield on the benchmark 10-year Treasury note fell as low as 1.89 percent last Wednesday as investors sold stocks heavily and bought bonds. They are now trading around 2.22 percent.

Davidson views the recent stock sell-off as a normal, periodic slump, rather than the precursor to a market crash.

The stock market hasn't had a correction, Wall Street speak for a drop of 10 percent or more, in more than three years, an unusually long stretch. Many analysts consider the current volatility as a natural part of stock investing. Typically, the stock market experiences a slump every 18 months, on average, according to data from S&P Capital IQ.

By Tuesday, the likelihood of such a slump appeared to be fading as the S&P 500 jumped almost 2 percent, after encouraging news on the global economy, and some strong corporate earnings. The index has risen four straight days.

There are reasons to remain cautious, though. Before jumping back into the stock market, investors should look at developments in commodities, says Jeff Kleintop, Charles Schwab's chief global investment strategist.

This month's stock sell-off was driven by a fear that deflation, or falling prices, could start in Europe and spread throughout the global economy, says Kleintop. Lower prices might seem like a good thing, but a sustained fall pushes consumers and companies to cut back on their spending and wait for lower prices. It's a difficult cycle to break and can devastate economies.

Oil's plunge this year has stirred fears of deflation. Crude has dropped 26 percent from $106.91 a barrel in June, to as low as $81.10 on Monday. For that reason, investors should wait until they see oil stabilizes before buying stocks.

“I want to see commodity prices rise, before I believe that the stock market rally is sustainable,” says Klientop.

One other reason to shift more to stocks, market watchers say, is that the recent sell-off has made them relatively cheaper.

The price-earnings ratio for companies in the S&P 500 index has fallen from a high of 17.2 in June to 14.7. That's about where it was in February. The P/E ratio measures how much investors pay for stocks of companies in relation to next year's earnings.

Investors should view the stock sell-off as a “nuanced opportunity,” not an opening to rush into the market, says Russ Koesterich, chief investment strategist at fund manager BlackRock. While valuations are lower, stocks still aren't “particularly cheap.”

Koesterich says that buying the stocks of larger U.S. companies is one of the soundest strategies. That's because the U.S. economy will continue to expand, although at a muted pace, and these stocks should offer the best cushion should markets become volatile again.

General Electric CEO Jeff Immelt seemed to underscore that point on Friday after the conglomerate posted strong third-quarter results. Immelt acknowledged the uncertainty in the global economy, but said that nations are still going ahead with large building projects and companies are buying equipment.

GE also issued an upbeat forecast for the fourth quarter, a crucial prediction because GE is seen as a proxy for the global economy.

“I wouldn't be selling out of stocks,” Koesterich says. “You can trim a bit if you're worried about volatility.”

For other investors, the best strategy is simply to do nothing and wait out the bumps.

Ron Wiener, CEO of RDM Financial Group, an investment advisory firm that has offices in Westport, Connecticut, and Boca Raton, Florida, says he didn't sell any of his holdings during the recent slump.

He invests mainly in U.S. companies. He also holds so called Master Limited Partnerships, MLP's, which own pipelines, holding tanks and other equipment that transport fuel to consumers. They have been popular with investors in recent years because the firms are required by law to “pass through” much of their income to shareholders.

“Looking back in six or nine months, we're all going to wish we stayed exactly where we were,” Weiner says.

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