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After two years of calm, are you wondering whether bigger daily stock market moves are signaling changes ahead? And if so, how can you prepare? Investment Strategist Kate Warne looks at the state of the market today and offers tips you can use right now.
Stocks started the year at a sprint, reaching new highs on improving fundamentals. Stronger global growth and the impacts of the U.S. tax cuts have brightened the outlook. Edward Jones expects modestly better U.S. economic growth and strong company earnings growth in 2018, and both can support rising stock prices over time.
But modest economic growth and rising wages have led to concerns about rising inflation and pushed interest rates higher. And the Federal Reserve expects regular short-term rate hikes this year. In addition to the first big pullback in two years, changing conditions have prompted bigger daily market moves – both up and down – which we think will continue. High stock market valuations and slowly rising interest rates could mean lower long-term returns as well as higher market volatility.
One way to measure valuation is the price-to-earnings ratio for the S&P 500. Even with the recent pullback, it’s still above its long-term average, showing stock valuations are high. But valuations have been above-average since June 2014, and over that time, stock returns averaged more than 12% per year.* Market volatility includes small pullbacks, which are frequent, as well as drops of 10% or more, known as corrections. They’ve happened almost every year regardless of whether valuations were high or low. But since the past two years were quite calm, without a correction, higher volatility may seem surprising. That’s why it’s important to have a longer perspective and stay prepared.
Valuations have been a good guide to long-term returns, and both stocks and bonds are relatively expensive right now. In the past, above-average valuations have been followed by below-average long-term returns, leading us to expect below-average portfolio returns over the next decade. Edward Jones expects U.S. stock returns over the next 10 years to be below 6%, which is less than our range for long-term expected returns. More important, we think U.S. stock returns are likely to be well below recent performance. As a result, we’re helping investors prepare for lower long-term returns with well-diversified portfolios and realistic expectations about how much to invest and withdraw over time.
Stocks started the year strong and then stumbled. Keep in mind that investing is a marathon, not a sprint. Maintaining a steady pace when conditions change can help keep you on track and able to go the distance. Along the way, market drops and volatility are inevitable, so don’t let them upset you – you can be prepared rather than surprised. And when the fundamentals of economic and earnings growth are solid, pullbacks can offer opportunities to buy stocks at lower prices, helping improve your portfolio’s long-term prospects.
If it’s been more than a year since you reviewed your portfolio with your financial advisor, now would be a good time to check your investment mix so you’re ready for the next stage in the investing marathon. The strong recent performance of U.S. stocks may mean you need to rebalance your portfolio. Consider adding fixed income to return to the right mix of stocks and bonds based on your comfort with risk and long-term financial goals.
*Source: Bloomberg & Morningstar Direct, 12/31/2017. Past performance does not guarantee future results.
This information is for educational and illustrative purposes only and should not be interpreted as specific investment advice. Investors should make investment decisions based on their unique investment objectives and financial situation.
Diversification does not guarantee a profit or protect against loss in declining markets.
Before investing in bonds, you should understand the risks involved, including credit risk and market risk. Bond investments are also subject to interest rate risk such that when interest rates rise, the prices of bonds can decrease, and the investor can lose principal value if the investment is sold prior to maturity.
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