The usual mixed bag
9/01/2019 2:52:15 AM //
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What if Charles Dickens had begun his classic “Tale of Two Cities” as follows: It wasn’t the best of times, it wasn’t the worst of times, it was the usual mixed bag.
While the statement may reflect reality, it doesn’t grab your attention half as well as Dickens’ actual opening sentence describing the French Revolution. As he concluded about the period, “Some of its noisiest authorities insisted on its being received, for good or for evil, in the superlative degree of comparison only.”
Thus, we’ve long known about our infatuation with extremes – Best! Worst! Delight! Despair! These are the sentiments that fuel our dreams and inspire our works of art. But you do yourself a disservice if you allow superlatives to rule your investing. In capital markets, if you get caught up in extremes and devalue the sweeping tides of time, you risk giving up your greatest edge: a clear-eyed understanding of what’s really going on.
As we reflect on the events of 2018, here are two evidence-based points worth repeating:
1. “Average” annual investment returns aren’t typical; in fact, they’re rare.
To quote a more contemporary source than Dickens, Cliff Asness of fund manager AQR recently observed, “This world is pretty much designed to convince us that we’re always at DEFCON 1, when 5 is the mode and 4.5 the mean.”
Other year-end analyses concluded that market volatility for 2018 remained on the low side. Even the wilder swings toward year-end were not that remarkable in the grand scheme of things as noted by Jared Kizer, CIO at Buckingham Strategic Wealth. Jared points out that there are 21 other quarters with returns at least as bad as the S&P’s -13.5 percent return for Q4 2018, and he summarises them in this table:
And yet, many “noisiest authorities” have been quick to play up the superlatives, while downplaying how these sorts of best of times, worst of times conditions have long been more the norm than the exception in capital markets. As expressed in this Forbes column, “When you take the long view – and if you’re a long-term investor, then you should – you’ll see that what feels jarring right now is actually just a return to normal levels of short-term volatility.”
This brings us to our second point.
2. We are human; we are susceptible to recency bias.
While there are many behavioural biases that trick us into sabotaging our best financial interests, we’re especially interested in the damage recency bias could cause in current conditions.
Recency bias can trick your brain into downplaying decades of robust market performance data, while magnifying the run of unusually calm market conditions we’ve been enjoying relatively recently – essentially since March 2009. This in turn may lead you to lend more weight than is warranted to current volatility.
That’s not to say the ride will be fun if we encounter more turbulence ahead. But by remembering extremes are actually the norm in your quest to generate durable long-term returns, you stand a much better chance of preserving your objective perspective and your portfolio, come what may.
In our New Year blog we set out six financial best practices for 2019. Our first point of six is:
“Do nothing. Seriously. If you have a well-built investment portfolio in place, guided by a relevant investment plan, your best move in hyperactive markets is to let that plan be your guide. That often means doing nothing new with your holdings. We list investment inaction as a top priority, because “nothing” can be one of the hardest things to (not) do when the rest of the market is in perpetual motion!”
The message here is next time you find your stomach tightening at the latest frightening or exciting financial news, tune it out. Walk away. Go do something you love, with those whose company you cherish.
Joachim Klement, CFA recently wrote a piece on the CFA Institute’s excellent website titled Analyst Forecasts: Lessons in Futility. It’s a short read that we recommend to you. This is what Joachim had to say on stock market forecasts: “Anyone who claims to be able to predict stock markets over the coming year is, in my view, a charlatan selling snake oil.” Enough said.
Circling back to our ‘do nothing’ call to inaction, not only will this feel better, it’s likely to be better for your financial well-being.
None of us know what the markets have in store for us in 2019 and beyond, but that doesnt mean that we can't have a robust financial plan in place. If you need any help with that just let us know.
If you don’t have any immediate questions but would like more information on the above and wider themes, then you might enjoy our recent video posts and blogs.