It’s an Official Correction... Now What?

Alexander Green
by Alexander Green, Chief Investment Strategist, The Oxford Club
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The smooth ride that the stock market gave investors over the past few years ended abruptly over the past week.

Unless you've been living on another planet, you know that the S&P 500 entered official "correction territory" yesterday. (It pulled back more than 10% from its recent high.)

Investor psychology has been damaged - and trading is likely to remain choppy for a while.

After a sell-off like this, it typically takes anywhere from a few weeks to a few months for a bull market to get back into a solid uptrend.

This is normal and healthy. So don't let it stop you from looking for new opportunities.

Bargains exist for those with the insight, the courage and the cash to take advantage of them.

Let's keep things in perspective, too. The money you have in the market should be left untouched for at least three years, and preferably five.

Why five? Because that's the average length of time from the start of a bear market to the next all-time high.

If you don't need your equity money for five years - or longer - what difference does it make what the stock market does this week, this month or this quarter?

Except - again - you want to pay attention to see what kinds of opportunities develop.

Over the last few years, some investors started to believe it wasn't beneficial to have money in lower-returning investments outside of the stock market.

As equities buckled over the past few sessions, however, they got reminded that having money outside of the market can provide ballast when stocks are behaving badly.

That's why you should always keep some cash in reserve, make bonds part of your asset allocation and, particularly with the inflation news of the past few weeks, own some Treasury Inflation-Protected Securities (TIPS).

Still, keep in mind that what has hurt the market lately has not been bad news but a superabundance of good news.

January was the 88th consecutive month of job creation, the longest streak of continuous hiring on record.

The tightening labor market helped lead to the biggest annual increase in wages in eight years. Nationwide, average hourly earnings for all private sector workers in January were up 2.9%.

(And the pickup in wages does not yet reflect the recent wave of announcements from companies that offered bonuses as a result of the new tax cuts.)

The news created fear that inflation may come in higher than previously expected - and that the Federal Reserve may increase rates more aggressively.

Dampening that expectation, however, is the fact that oil prices have fallen and the dollar has risen. There are good reasons to believe that neither move is temporary.

International investors shop currencies for yield the way CD investors shop banks for yield. U.S. rates are considerably higher than they are in Europe and Japan - and are almost certainly headed higher still. This will attract foreign investment capital and boost the dollar.

U.S. shale producers spent the last three years tightening costs and improving their efficiencies so they could make money at lower prices. Now they are set to flood the market with oil again.

In fact, they already are. The U.S. Energy Information Administration announced that in November, U.S. oil production exceeded 10 million barrels a day for the first time in nearly 50 years.

This will help push oil prices lower.

In short, the market action in recent weeks was based on three factors:

  1. The threat of higher inflation
  2. The possibility of more Fed hikes
  3. The longtime absence of a normal and healthy market shakeout.

There are likely to be more quakes and tumbles in the days ahead.

But the longest hiring streak on record, the biggest jump in wages in eight years and the strongest service sector in 10 years - plus cheaper energy and a stronger greenback - are all good news.

And fourth quarter earnings reports are mostly beating expectations. So don't let the market turbulence undo your well-laid investment plans and keep you from reaching your important financial goals.

It's a mistake to get shaken out of the market on bad news. But it would be a far bigger one to do it on great news.

Good investing,

Alex

Thoughts on this article? Leave a comment below.

Take These TIPS to the Bank

It's completely natural to feel a nervous about how the stock market's behaved lately. But while humans are wired for fight or flight, fleeing the market completely right now would be a bit irrational. Instead, protect your interests with some extra insurance through Treasury Inflation-Protected Securities (TIPS).

In Tuesday's Oxford Communiqué portfolio update, Alexander Green reminded subscribers of his preferred Vanguard Inflation-Protected Securities Fund (VIPSX) and its exchange-traded fund (ETF) equivalent, the iShares TIPS Bond ETF (NYSE: TIP)...

With the market news we've gotten recently, it's worth remembering to always keep some cash in reserve, make bonds part of your asset allocation and own some Treasury Inflation-Protected Securities (TIPS).

As noted above, the tightening labor market and rising wages has created fear that inflation may be stronger than expected. (As a result, the yield on the 10-year Treasury note hit 2.85% on Friday. It was near 2% in September.)

Inflation is the great enemy of both stock and bond investors. (And even more so for holders of lower-returning cash.)

That's why it makes sense to own an insurance policy in the form of TIPS.

Ten-year TIPS now pay 0.55% plus the official rate of inflation.

The bonds are backed by the full faith and credit of the U.S. federal government and pay interest every six months, just like a regular Treasury bond.

But, unlike traditional bonds, your principal increases each year by the amount of inflation, as measured by the Consumer Price Index. Semiannual interest payments also increase by the amount of inflation.

The interest you receive is exempt from state and local (but not federal) income taxes.

TIPS are less volatile than traditional bonds. They are also excellent diversifiers.

You can purchase TIPS directly by clicking here.

Or you can own the Vanguard Inflation-Protected Securities Fund (VIPSX) - or its exchange-traded fund (ETF) equivalent, the iShares TIPS Bond ETF (NYSE: TIP).

(The funds are part of the Vanguard mutual fund version and the ETF version of The Oxford Communiqué's Gone Fishin' Portfolio.)

Some investors complain that TIPS have done nothing exciting the last few years. They are not understanding the role these securities play.

They're meant to reduce the excitement in your portfolio, not increase it.

Moreover, returns have been modest because we've been in a low-inflation environment. Recent data indicates this is about to change.

Aside from increases in wages and consumer prices, the debt created by unfunded entitlements and other government spending will increase the national debt, potentially putting further pressure on consumer prices in the future.

TIPS protect your purchasing power. If you don't already own a slug of these bonds, you should. Preferably in your retirement account where they can compound tax-deferred.

- Donna DiVenuto-Ball with Alexander Green

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