The Power is in Perspective NOT Prediction
FIVE THINGS YOU SHOULD KNOW
- Equity Markets – rose this week with U.S. stocks (S&P 500) up 0.91% while international stocks (EAFE) gained 1.03%
- Fixed Income Markets – ran lower this week with investment grade bonds (AGG) down -0.43% while high yield bonds (JNK) fell -0.28%
- Unemployment Sees Sharp Improvement – The month of July saw an 11-month peak of 943,000 jobs added while the unemployment rate fell 0.5% to 5.4%, the lowest level since the pandemic began. While concerns around the Delta variant of the virus (among others) continue to cloud expectations, it was a positive sign that July’s strength also occurred amidst the first month of decreasing governmental support to the economy.
- Crypto Crackdown – Securities and Exchange Commission (SEC) Chairman Gary Gensler’s speech this week at the Aspen Security Forum reiterated the SEC’s goal of creating stricter oversight and regulation on the cryptocurrency space in the near future. Gensler has already made a formal request to Congress to grant the SEC authority to monitor crypto-exchanges, with the SEC unwilling to approve any bitcoin exchange-traded funds (ETF) in the meantime.
- Key Insight – [VIDEO AND ARTICLE] While market crashes naturally lead to heightened investor anxiety, ironically so do new all-time highs in markets. We discuss some of the key misunderstandings that spook investors out of markets pre-maturely as they try to predict and share some great historic facts/charts we rely on to gain a better perspective to navigate complex markets.
INSIGHTS for INVESTORS
As the market continues to push higher, many people’s anxiousness continues to grow around when the next pullback (or worse) will occur.
Much of their outlook seemingly comes from either of the following beliefs/sentiments:
1) the market usually crashes after hitting an all-time high, and/or
2) “what goes up, must come down.”
For some, this anxiety compels them to try and act on what they feel what must happen in order to avoid the financial and emotional pain of a market drawdown … in other words to predict the future.
Whether you are an investor simply experiencing unnecessary anxiety or going one step further and trying to predict/time the next pullback, my hope is this week’s commentary will help you avoid the pain of both by sharing a few key facts, as well as some great charts courtesy of our friends at AMG Funds.
The tough reality is that volatility is an avoidable price every investor must pay to make money over time. Equally tough is keeping a healthy perspective when your emotions are triggered. It is a fact that scary markets trigger us deeply, in almost exactly the same way as being put in mortal danger. Put it all together and you can say that we are literally hard-wired to be bad investors.
One of the only ways to improve your odds of success and staying the course during such challenging times, is to have learned some key market facts that can help you keep perspective in advance of volatility when you are most able and willing to listen and learn.
Takeaway #1: The time spent worrying about Bear markets is greater than the length of most actual Bear markets.
For many investors, and virtually all pundits, corrections, crashes and trying to predict when the next one is likely to occur is of endless fascination, regardless of where we are at in a market cycle. This means from beginning to the end of every bull market, people are busy worrying about the next bear market.
Some examples:
1) Beginning of a bull market – Right after a market crash, you’ll hear people say “the next shoe is about to drop” and any bottoming is simply a “suckers’ rally”.
2) Middle of a bull market – during the inevitable corrections which occur throughout a bull market, people are confident it’s the beginning of a new bear market and more pain must be ahead.
3) “False” Ends of a Bull market - As we discussed above, even during good times people assume every new all-time high signals THE end, because eventually some peak will occur that is in fact the end of the cycle.
Now the truth around each of those sentiments:
1) While bear markets feel like they are never going to end, the reality is when it feels/looks the worst, is usually right when the next bull market has begun (e.g., think about your sentiment and the headlines on March 23rd of last year, or the headlines in February 2009 calling for the complete collapse of the US economic system). The truth is, markets bottom on the worst news, which is why famed investor Sir John Templeton said, “bull markets are born on pessimism.”
2) Corrections, as we’ll see in the next takeaway, are a regularly occurring event, and the majority of them never become bear markets. This means the “head fake” which poses the most danger, is aimed at those choosing to sell during a correction, not those choosing to buy.
3) We’ll touch on this more below, but the reality is the vast majority of all-time highs lead to more all-time highs, not a crash
What is the result of these three misunderstandings/mistruths? It is people grossly underestimating the length and scope of bull markets, and in doing so not only missing out on meaningful potential gains by staying the course, but unnecessarily worrying all along the way.
Look at the chart below, both in terms of time and scope. If you are going to worry, what stands out as the greater worry/threat?
1) Falling prey to one, or all, of the first three misunderstandings above and being spooked out of the market for any meaningful period of time?
OR
2) Needing to PLAN financially and emotionally for getting through a tough 18 months every 8 or so years?
Takeaway #2: New All-Time Highs Usually Lead to … More All-Time Highs.
It never ceases to fail that as soon as one headline trumpets a new high for the stock market, out come more headlines or pundits predicting the next crash is around corner. Yes, eventually after some all-time highs the market peaks and experiences a correction (defined as a decline of 10%) or crash (defined as a decline of 20%+), BUT that isn’t what occurs after most.
As you can see in each of the green segments in the chart below, which reflect the timeframes of historical “bull markets”, there are many new all-time highs during such bullish periods. If an investor simply sold upon the news of a new all-time high, they would miss out repeatedly on many of the gains to be found over time in the market.
Sure, at some point the “music” stops for a bit and the markets experience a correction or crash (more on those in a bit) but the reality for most risk assets (e.g., stocks, real estate, etc.) is their general trajectory over time is up. Thus, the sentiment “what goes up, must come down” falsely assumes there is some flat base line that risk-assets must return to (i.e., a ball returning to earth). However, the reality, as you can see from the chart below, is that the periods of expansion outweigh those of contraction in both time and scope resulting in a consistent lift to prices over time.
Takeaway #3: Corrections are Frequent, but they aren’t Fatal
What have we learned so far in a nutshell? First, bull markets are much larger in terms of both their gains and timeframes than virtually any bear market. And second, markets tend to rise over time as opposed to returning to some previous level.
And yet, what also holds true, is a correction (classically defined as a drop of 10% or more) and/or decline of near 10% happens almost every year at least once.
Consider the chart below looking at just the last 23 years, (other than the anomaly of 2017 which in all of history has only one other year like it), the market pulls back at least once a year by 5-15%! Each one has scared many investors into believing it was the start of the next big one.
And yet, despite all that volatility, only two of those years resulted in a loss of 20% or more, and in only five of them was the calendar year negative at all (with three of those years coming in the dot com crash).
Frequent? Yes. Fatal? No.
Final Takeaway – Perspective buys time, time buys Performance.
Averages are dangerous in that they set false expectations. Faulty expectations result in disappointment and in turn, disappointment short-circuits many solid plans.
Remember averages happen over time, not all the time.
As you can see from the chart below in any given year, the dispersions of potential returns across assets, and even diversified portfolios, can be quite large. However, for those investors that give a well-built portfolio time, not only does the gap in potential returns narrow, but one’s odds of having a positive return become a near certainty.
This is why time, coupled with diversification (tune in next week) are so critical to getting you the returns you need … and time is bought with a proper perspective.
In Summary
Look, market volatility and the corresponding portfolio drawdowns are awful and scary. As we’ve shared before, they literally trigger the part of your brain that is triggered when you are in mortal danger – so it’s understandable that people want to avoid them. However, the problem is, timing them using any method, is difficult to near impossible.
Engaging in trying to predict markets is likely to create a far greater loss of potential wealth than any given bear market could inflict.
My hope is that you’ll tuck this commentary away somewhere, whether you are feeling anxious today or get “triggered” by something later on and be able to pull it out and use it to keep a proper perspective and give yourself the best chance to succeed.
Next week, we will look what a good plan entails and how, just like a good perspective, it is of far greater value than anyone’s predictions.
Have a wonderful weekend and enjoy the view from your new perspective!
Tim and the team at TEN Capital