Dan Reiter, CFP®, CPA
In the final weeks of 2024 following election day, markets were broadly positive as investors considered the promises and policies put forth by President-Elect Trump and other winning candidates during the campaign season. It seems the initial positive response was due to visions of business-friendly policies such as tax cuts and deregulation that often buoy markets.
Since inauguration day, however, it has become clear that the policy priorities (at least initially) are focused on international trade. After a whipsaw quarter of hot and cold headlines related to on- and off-again tariffs, now President Trump held a widely anticipated press conference last Wednesday to announce his larger plans. During his speech on which he has referred to as “Liberation Day”, Trump unveiled duties that, according to the Yale Budget Lab, will increase the average effective U.S. tariff rate from 2.5% in 2024 to 22.5%.
The result so far? Concerns about what tariffs might mean for global stocks and consumers. A two day rout in the market last week that erased $6.6 trillion in market value. The tech-heavy Nasdaq index, specifically, has now entered a bear market, defined as a 20% decline from a previous high.
Investor sentiment has also swiftly declined this year. The CBOE Volatility Index (VIX), often colloquially referred to as the “fear gauge” has hit its highest closing level since April 2020, a record at that time. International sentiment is also falling, with the Eurozone Sentix economic index hitting its lowest value since October 2023 and experiencing the sharpest decline since Russia’s invasion of Ukraine in 2022.
Amid heightened fear and declining sentiment, it is important to keep a firm hold on the big picture, however. For one, there have been more than a few signs that the strength of the economy continues to hold steady. In a headline on Friday of last week that was largely overshadowed by tariff concerns, the Labor Department reported that the U.S. added 228,000 jobs in March, significantly higher than the 140,000 expected.
Moreover, economic growth in the U.S. has averaged nearly 3% since 2022. At 4.1%, unemployment is at a rate most economists would refer to as normal. Finally, on another positive note, the February inflation report of 2.8% was lower than the 3% gain expected by economists.
To be clear, what we are not saying is that economic numbers are absolute proof that it’s all sunshine and rainbows. What we are saying, however, is that there might be a few less ominous clouds in the sky than you might think.
As we once more enter a time of heightened uncertainty, we feel it is critical to remind investors what they can (and should) be doing to navigate more turbulent markets. In the words of the late investor John Templeton, we firmly believe in the timeless truth of his words:
“The four most expensive words in the English language are: ‘this time it’s different’”
For most readers this period of volatility is not the first – nor will it be the last – time we experience an unsettled and declining stock market. However, the most successful investors are those that follow the principles we discuss below, where we outline what steps investors should be taking to protect themselves during current market conditions.
What Should Investors Be Doing in This Uncertain Time?
Although the recommendations we describe below are timeless, we feel it is also important to relate them to what investors face today. That said, there are three recommendations we have for investors to consider:
- Focus on what you can control,
- Don’t allow emotional sentiment to dictate investment decisions, and
- Consider diversification opportunities within your portfolio.
Recommendation #1: Focus on what you can control.
Unfortunately, the stock market is one thing that none of us have the power to control. Fortunately, though, there are several actions that are fully within your control you can take amid market volatility to protect yourself financially.
First, review your cash reserves. Do you have sufficient cash to cover any short-term emergency expenses? Consider your medical and other insurance deductibles, as well as certain potential costly repairs to your home such as your HVAC. Especially in periods of heightened market volatility, you should consider having a minimum of six months’ worth of expenses in a high yield savings account. Consider also holding in cash any amount you expect to need in the next 12 months for larger expenses such as home repairs or car replacements.
Second, review how many years of bonds that you have for the intermediate term. This is especially important for those in retirement or nearing retirement. In normal market declines, bonds often hold their value or see moderate increases in value as investors flock to safety. Target at least five years’ worth of bonds in your portfolio.
For example, if you expect to retire in two years and then withdraw $10,000 per month, you should target at least $360,000 in bonds. Holding sufficient cash and bonds to cover at least five years’ worth of expenses will help to significantly limit the likelihood of being forced to sell stocks before they have a chance to recover.
Third, consider updating your financial plan. Market volatility is something that we make it a point to prepare our clients for. It is always a matter of when, not if, the next downturn happens. As such, it is important that you consider having a margin of safety in your plan so that when market downturns happen, they do not impact your goals. Reviewing your plan and goals may also serve as a helpful reminder to help reestablish confidence for those who have made such plans already.
Recommendation #2: Don’t allow emotional sentiment to dictate changes to your investment strategy.
First, let us start by saying that fear and loss aversion are normal. Very few relish the idea of seeing red ink and declines on their investment statements. It is okay, and normal, to feel unsettled in times of heightened uncertainty.
When a large percentage of investors start feeling more unsettled and more uncertain, though, market declines occur. Moreover, market declines typically result in more fear and more selling of stocks thus often heightening the decline further. The result is a cycle that lasts until sentiment begins to change.
Observers of stock market history see such cycles repeatedly throughout the past. Viewing them with a critical lens, there is an important lesson that such observations teach us. The lesson is that sentiment can change very quickly, and with it the direction of the stock market. Moreover, the best investment gains found are often at the end of some of the steepest declines.
In fact, high levels of fear and low levels of investor confidence have historically been predictive of higher-than-average forward-looking returns. According to one survey, the S&P 500’s return following the 10 worst years for investor sentiment was followed by an average return of 18.9%.
To review a recent example, as discussed earlier, the current rise in the “fear gauge” volatility index (VIX) hit levels second only to those seen in April 2020. As the Covid outbreak occurred throughout the globe, investors went on a selling spree which resulted in the US stock market dropping 34% in just 23 days. What happened shortly thereafter? Within a year, the market not only recovered, but rose 78% from its lowest point. As John Templeton would agree, those that sold stocks during the Covid outbreak under the belief that it was “different this time” made a very expensive mistake.
As illustrated by the chart below, another sentiment index - the Consumer Sentiment Index established by the University of Michigan - shows current consumer sentiment at 57. While not at the lowest point it has ever been, it is now nearing levels previously seen in historical sentiment troughs, including those in November 2008 and August 2011. The S&P 500 index return in the 12 months that followed these periods were 22.2% and 15.4%, respectively. In a review of nine prior sentiment troughs in history, the average subsequent 12-month performance of the S&P 500 index was 24.1%.
SOURCE: JPMorgan Guide to the Markets dated April 4, 2025
Unfortunately, though, knowing when we are in a sentiment trough or at market bottom is an impossible task. It is possible that both sentiment and the stock market with it may continue to decline in the near term. It is also possible, though, that both may swiftly rise.
The point is this: History is clear that one of the worst times to sell stocks is when fear levels are high.
Recommendation #3: Evaluate opportunities to diversify your portfolio.
In our Fourth Quarter Economic and Market Update written in October of last year, we continued to caution against an overconcentration in large US companies, particularly the largest handful of companies such as the “Magnificent Seven” – Apple, Microsoft, Amazon, Alphabet, Meta, Nvidia, and Tesla. Specifically, we wrote about how the largest companies in the US made up a larger percentage of the market and traded at higher prices than smaller companies and those outside of the technology sector. These companies hit a collective price-to-earnings ratio of 46 times last December.
Stocks, at high valuations, are “priced for perfection”. Meaning, expectations that are already high must be exceeded to achieve expected returns. Often, any case of bad news tends to upset the apple cart. At these types of valuations, the toughest competitor is often their own past performance, or the expectations that such a past creates for the future.
In other words, during periods of high expectations and optimism, any challenge to the status quo can be disruptive. As more fear of economic disruption has entered into the picture this year, these stocks have fared worse than most with a 23.5% decline year-to-date, compared with only a 6.2% decline in the other 493 companies in the S&P 500 index.
While prices relative to earnings for the largest stocks have declined this year as a result, they are not yet trading at bargain levels. While we do not believe eliminating exposure to these companies entirely (there are still some great large technology companies), we do feel that continuing to overlook opportunities in other companies outside of large technology is a mistake to be avoided.
One bright spot in markets this year has been international funds, which broadly gained 6.4% in the first quarter and significantly outperformed those in the US. Domestic stocks have largely outperformed those outside of the US in most of the prior decades. However, this phenomenon known as the “American exceptionalism trade” is now being challenged.
For one, much of the growth in the US stock market over the past two decades has been supported by international investment. US stocks now make up approximately 72% of global stocks, up from about 47% in 2008 and foreign investors now own almost 20% of all U.S. equities compared with 7% at the start of the century.
Why? The US dollar has strengthened significantly against international currencies. As this has occurred, returns for foreign-owned US stocks have increased even further. Even excluding the Magnificant Seven, Americans who bought the rest of the S&P 500 15 years ago earned a total return of around 380%. Europeans, however, earned about 490% as the dollar grew about 20% against the euro.
It is worth mentioning that this currency impact works in both directions. The strengthening dollar has worked against US investors owning overseas companies. However, should the dollar continue to weaken against other currencies, owning international stocks may be a protective hedge.
Notably, it has also not been that long since we have seen a period of prolonged broad outperformance of international equities over those in the U.S, excluding the impact of currency changes. In the early 2000s, investors turned against U.S. growth and technology stocks in favor of those overseas. During this period between 2000-2009, the so called “lost decade”, the S&P 500 had a negative annualized return while international stocks performed quite well.
Uncertainty may continue in the coming weeks and months, but we believe investors who are properly diversified will set themselves up for better risk adjusted returns in stocks. Diversification might be a lifeline for investors, rather than just a strategy to consider.
Investment advice, financial planning, and retirement plan services are provided by Prosperity Planning, Inc., an SEC registered investment advisor. The information contained herein, including but not limited to research, market valuations, calculations, estimates and other material obtained from these sources are believed to be reliable. However, Prosperity Planning, Inc. does not warrant its accuracy or completeness. Past performance may not be indicative of future results. The information contained herein has been prepared solely for informational purposes and is not an offer to buy or sell or a solicitation of an offer to buy or sell any security or to participate in any trading strategy. If an offer of securities is made, it will be under a definitive investment management agreement prepared on behalf of Prosperity which contains material information not contained herein and which supersedes this information in its entirety. Any investment involves significant risk, including a complete loss of capital and conflicts of interest. The applicable definitive investment management agreement and Form ADV Part 2A will contain a more thorough discussion of risk and conflict, which should be carefully reviewed before making any investment decision.
