State of the Markets Address

I thought it would be fitting to pen a “State of the Markets” address, seeing this is the day after the president’s final state of the union address. In this post, I hope to address where the markets have been, where they are now, and where they will go.

 

But before I do that, I want to remind people of the human tendency to believe in the permanency of the current state, and how it “must” and “will” perpetuate into the future. Back in 2008, I printed off an article that read “What $300-a-Barrel Oil Will Mean for You”.  It was from Barron’s magazine (not exactly a low rate publication).  At the time gas prices were high.  China was expanding rapidly.  Oil was supposed to be rarer and rarer to find.  We were told we didn’t have enough refineries.  The narrative seemed completely logical!  In fact, most of the statements in the article were probably true.  But I have to repeat one of the article lines just so you can read it: “We will see $300 a barrel – or roughly $250 in today’s dollars- because oil supply will be so short.  If you want that oil, that is what you will have to pay for it. That will be in 2015, after the peak of oil [supply]”.  Needless to say, that prediction was very very wrong.  Today oil and gas are cheap.  However, at the time, the article seemed so spot on.

 

The same can be said today. We have all sorts of problems.  ISIS, the National Debt, the cost of Medicare, crumbling infrastructure–and a litany of other problems.  It seems to make logical sense that this most recent decline in the markets is just a first step in the permanent unwinding of society.  But then again, we have had problems before.  In the early 40s the Allies were not winning World War II.  In the early 70s we faced an oil embargo and the stock market was halved.  We almost went to war with the USSR in the 60s.  A fundamental requirement for investing, is being able to accept the negative news of today, and believe that businesses and economies are resilient, and will preserve through many storms.  If you do believe that this is “the end”, you might as well take your money and bury it in your back yard.  A positive long term outlook is required for investor peace of mind.  Otherwise investing will be a stressful endeavor filled with fear and anxiety.

 

But, if it is your belief that this is indeed NOT the end of it all, then we must assess where we are, and whether or not it is unique in the long history of the markets. Let’s start with a brief review of where the major markets have been.  By most broad measures, the international stock markets (in aggregate) are in bear market territory (a decline of 20% or more).  US large stocks are not yet in bear market territory, but are about half way there.  US small stocks are in bear market territory by most measures.  So let’s acknowledge that.  Many areas of the market are in a bear market.  Then we must ask, how frequent is this?  If we look at the US market (as measure by the Dow Jones), a bear market (decline of 20% or more) occurs every 3 ½ years.  When was the last bear market for the Dow Jones?  2009. That is 6-7 years ago if my math is right.  The average duration has been 338 days.  That is from high to low- the ride down.  So, from history we can see very clearly that declines of 20% or more are very routine, happening every couple of years.  There is nothing abnormal about what is occurring now.  If you are interested in the duration of bear markets, from beginning to recovery, the average time is about 3 years (this is according to an article from wealthfront.com from 2/12/15).  The article looked at market corrections in the S&P 500 index, a US large company stock index similar to the Dow.

 

So, if we distill the above down to a few points, they are as follows:

a) The markets can and do decline. End of statement. That is reality.

b) They do so frequently. Every few years on average.

c) The sharpness of this decline is 20% or more, and will come with all of the expected gloom and doom media coverage.

d) They take time to play out. On average it will be a few years from top, to bottom, and back to the previous high.  Patience is required, along with a positive attitude.

 

Instead of being portfolio destroyers, these declines are actually opportunities to buy in at lower prices. That is where the money is made.  Not by investing just when things are rosy and the markets are high.  I believe Warren Buffet once said he would welcome a 50% decline in the value of all of his stocks- for that very reason.

 

No one can predict with certainty when this bear market will end, but at some point, it will. A new bull market will emerge, only to be followed again by another bear market in the never ending cycle of the markets.  While this history replays itself time and time again, it is only human nature to feel that this time “things are different”, or “we have never had this”, or “we can’t come back from these circumstances”.  Each of these statements could have been made about a prior bear market, but yet here we are today.

 

I’ll leave you with one of my favorite investing verses from Ecclesiastes 1:9 that sums up the disciplined view of investing:

“What has been will be again, what has been done will be done again; there is nothing new under the sun.”

 

Breaking the Vicious Cycle

If you have been watching the markets at all this year, you know it has been a rocky start to 2016.  As I write this the S&P 500 Index is down 5.91%,  and the MSCI ACWI ex US Index is down 6.29% (an International Stock Index).  While there are several ideas I could write about, I thought I would talk about what troubles me as a financial advisor, and it is not the markets.

It is an inevitable fact that markets correct.  They go down, and sometimes they even crash.  It’s an inescapable fact of investing.  And sometimes they go that way for a long time.  I recall earlier in my career enduring the market decline of 2000-2002.  It was three agonizing years of poor performance.  And during that time many investors made emotional decisions that were, in retrospect, perhaps a mistake.

So much of the failure of investors lies in their inability to endure market declines, and trust or understand the markets.  The markets themselves are usually never the problem- the problem is a reaction to them.  If we look at the historical returns of owning equities, volatile as they are from year to year, they have been a great long term hedge against inflation.  So many people do not understand what they own when they own stocks, or equities.  When you own stocks, whether individually or in a fund, you own the very companies that make everything we see before us in the world.  From homes, to planes, to the truck that hauls away your garbage- companies that produce the goods and services that society needs.  So, for the market to really truly decline perpetually, it would mean the total decline of our economic system, as all companies slowly become worthless.  That is the sole scenario where investors, and everyone, loses.

So many investors encounter a period of market decline and volatility, and because the returns are not immediate they “give up” on sound investment strategies.  Make no mistake, there is no get rich quick method to investing.  More often than not, if it seems to good to be true, it is.  Think about it; if a certain investment firm really had it all figured out as their product advertises, why would they need your money?  What really makes my heart ache for investors, is that their failure is so preventable, and yet predictable.  The process goes like this.  Investor invests, markets perform poorly, the impatient investor abandons their plan, and the markets rebound and the investor misses that rebound.  The investor’s new plan is a loser.  So they abandon plan b, and again go in search of the silver bullet of investing.  They go from strategy to strategy, and will likely earn about 3-4% per year, according to DALBAR’s annual QAIB Study.  That is the vicious cycle that all investors must escape to be a successful investor.  Only disciplined, educated, and steadfast investors truly earn “market” rates of return.

If investors were really educated, and understood what disciplined investing looked like, they could avoid the vast majority of issues.  That is why education is so important.  Please join us this year for our investor education series courses, to become a more disciplined and educated investor.