In mid-November, the U.S. stock market witnessed its first 10% correction since March 2003, as investors reassessed the growth potential of corporate profits for the rest of 2007 and 2008.  A market correction is defined when a broad stock market index, such as the Dow Jones Industrials Average or the S&P 500 Index, declines 10-19% from its last high point.  A bear market occurs when the stock market declines 20% or more from the index’s last high point.  For perspective, such market events are infrequent compared to rising market or bull market (+20%) periods.  But their occurrence, while short-lived compared to bull markets, come across to investors as being more acute and intense than rising markets and bull market periods.

For perspective, (stock) market corrections and bear markets can result when expectations and the ensuing reality of corporate profit growth slows or even declines.  In this particular period, the cause for the (stock) market’s correction stems primarily from what was a period of loose credit standards from 2003-2006 that fueled a housing market boom…and tragically, a subsequent housing asset-price bubble.  When the Federal Reserve slowly raised short-term rates from 2004 through 2006 to stave off the effects of growing inflation concerns, this commensurately raised bank lending rates and tightened their credit lending standards. 

With rising mortgage defaults, escalating foreclosure rates, and some financial institutions having to take back homes, financial institutions have taken enormous write-downs on soured subprime mortgages.  This was so extensive in the financial sector it had the effect of lowering 3^rd quarter S&P 500 Index corporate profit growth from an estimate of 2.4% earnings growth to an actual -9.5% earnings decline!  Incidentally, if you excluded the earnings decline of financial services, operating earnings for the 3^rd quarter actually grew 1.6% over the previous year.  So, the brunt of this came from slow to declining financial company earnings and select consumer discretionary companies. 

Weaker corporate profits ultimately translate into lower stock prices, which could further erode the confidence of consumers who are already feeling less wealthy as fuel costs rise and home values recede.  In the first two quarters of 2007, S&P 500 companies operating earnings rose at high-single digit growth rates from a year earlier, before dropping into negative territory in the third quarter.  For perspective, this recent profit weakness has followed a remarkable corporate profit run, because from mid-2002 to 3^rd quarter 2006 corporate earnings had been growing at double-digit rates for 18 consecutive quarters! 

While near-term (stock) market returns will remain volatile as the housing market resolves itself and consumers and investors adjust to it, no one truly knows how long this heightened market volatility will last.  But as historical backdrop, since 1950 the Dow Jones Industrials Average has seen 18 market corrections (declines of 10% to 19.9%), within a bull market period.  There have been 10 bear markets, or declines of 20% or more.  The average time for the Dow to recover from a bear market was about three years from the low point.  When it was a (stock) market correction, the market recovered and climbed above its previous peak on average within six months.  Only two (stock) market corrections since 1950 have needed more than a year to recover, and even then the Dow was back to its former high within two years.  And if the corrections and bear markets are taken together, the average recovery time is just a year and four months – good news for retirement investors who have a much longer investment horizon.

So as short-term fears over credit lending matters and the housing market’s correction continue, given you are retirement investors and (by default) are long-term investors, such matters should be discounted.  In other words, short-term market events are not in-line with your long-term investment focus.  With Freedom One’s MAPs, you’re a buy-and-hold investor already with a fully-diversified portfolio of stocks for long-term growth and bonds and cash for ballast, so you don’t need a place to ‘hide’.  Freedom One MAPs establish you with a diversified portfolio that rebalances annually, keeping you on an even keel, no matter which way the (stock) market winds are blowing. 

However having said this, bonds won’t always bolster your portfolio.  During the 16-month long recession from November ’73 to March ’75, it was cash that outshone the three major asset classes (stock, bonds, and cash).  During that recession, which coincided with the ’73-’74 bear (stock) market, stocks lost nearly 18% of their value.  But 90-Day Treasury Bills, a proxy for cash, generated double-digit gains; a 60-30-10 portfolio would’ve fallen only 8.4% during that period. 

Of course this raises the question: If one fears a pending economic recession, why not move entirely into bonds and cash?  The answer is there are significant risks associated with trying to time the market.  Because you have to be correct twice – once when you go out, and a second time when you go back in.  Even if an economic recession is imminent, there’s no guarantee how any asset class will perform during that brief period.  For instance, during the recession from July ’90 to March ’91, the S&P 500 actually gained 7.6%.  But, because of the stellar performance of bonds, a balanced 60-30-10 portfolio gained even more, returning 7.7%. 

At Freedom One we offer five risk-based portfolios of diversified stocks and bonds (MAPs) to outperform the market long-term.  They’re retirement portfolios that mitigate undue panic during a short-term crisis such as we’re currently in.  The MAPs are constructed to weather both the good times and bad times during the long road to successful retirement.  These risk-based portfolios are also rebalanced each year, and they employ a structured strategy designed to successfully capture the return of multiple asset classes, while minimizing stock and bond market risk.  Recognize there will be ‘bumps and twists’ along the way, but your path is set, and you’re on the right course. 

If you have any questions we invite you to call your respective Retirement Consultant or Client Relationship Manager.  We thank you for the trust and confidence you have placed in us.  Please know your 401(k) is our own employees' 401(k).  We’re in this together, and long-term, our Freedom One MAPs will serve us well.