Will it all turn out differently this time?
You too have probably heard this before.
In the investment world, analysts and investment managers get a bit dismayed when they hear the refrain: “It’s different this time.”
Because we heard these same words in the late 90s when many internet companies had sky-high valuations but weren’t making a dime. Because we heard: “It’s different this time” in 2008 when various experts told everyone the real estate market couldn’t possibly implode since the market was so well fragmented.
These predictions, and what eventually happened, should be permanently etched in every investor’s mind.
That’s not to say that the markets and the economy will always follow the exact same pattern. Nor does it mean that the status quo or conventional wisdom won’t evolve or change. After all, the smartest people all once believed the earth was flat.
Radically changing your point of view, while uncomfortable, can be a very good thing.
Obviously, there are a lot of axioms for the markets and the economy. Some of them have generally held true since the early 20th century, while others have faded away or don’t have the same potency.
For example, there’s an adage that says: “Sell in May and Go Away.” From 1950 to 2013, for the May-to-October period, the Dow Jones Industrial Average annually averaged an uptick of just 0.3%, while the November-to-April period averaged 7.5%.
Yet, sometimes, accepted “conventional wisdom” is neither. That’s because, historically, there have been many instances where the returns from May-to-October have been much better than the returns from November until April.
Just like axioms, there are some heuristics about when the markets are perceived to be at a crossroads. Here are a few that you may have heard:
- If there are that many bearish investors, the market can’t be that richly priced
- Valuations are extremely high, therefore future returns will be lower
- Commodity prices have not peaked, therefore we will not have a recession
- The unemployment rate has hit bottom, so it must now go higher
- The Fed will keep raising rates until the yield curve inverts and we have a recession
- Credit spreads are widening, a signal that a recession is looming
- Technological innovation will allow productivity to grow exponentially
- GDP growth is improving and will enable both higher stock prices and higher interest rates, without causing a recession
Sure, there are threads of truth in each of these. But they can’t all have the same implications for investors. Simply, the market can’t drop and increase at the same time.
We may just also find ourselves one day observing an economic path that has never been predicted.
The economy is evolving. Online consumption continues to increase. Right in their own hands, nearly everyone has a smartphone, a worldwide portal for shopping and buying. Some of the largest companies in the world have minimal assets but are rich in intellectual capital. While demographics in many countries will keep demand higher for bonds, millennials may not fit the mold of past generations (get a college degree, start a family, move to the suburbs and buy a house, save for retirement).
Things seem to have changed in a way that we’ve never had to deal with before.
On a separate note, we’ve also never had such a massive central bank balance sheet and unwound it before. (Meaning, the Federal Reserve took on a massive amount of assets during the financial crisis and is now in the process of reducing it.)
And, finally, there has also never been the level of ease to trade investments, nor has there ever been such volume of trading that is not directly tied to company fundamentals.
And with social media connecting everyone, will sentiment (and trends) change and correct and reverse more quickly than they have in the past? (We think so.)
Maybe history won’t repeat.
On top of all that, there’s political uncertainty in Europe and increased tensions with China.
While last year was one of the least volatile years on record, the next phase could certainly see much more volatility.
This just may be one of those eras where distinguishing between dawn and dusk is impossible.
Only time will tell. So, rather than focusing on what no one can predict, let’s focus on what we do know.
Volatility has increased and will probably stick around for some time.
The markets hate uncertainty and there appears to be too much uncertainty for volatility to be as contained as it was last year. This is due to:
- Higher interest rates
- Tariffs and trade wars
- Mixed economic indicators
- A very flat yield curve
- And collapsing oil prices
These are all early signs of the potential for major market instability.
Which is not all bad.
It’s not all bad because, for the long-term-time-horizon investor, volatility may allow the market to shake off some speculation, reset, and move higher.
Or, it could mean we just need to muddle through, hopefully not making bad emotional decisions and jumping in and out of the market along the way.
As history has shown, for very long-term investors, whether we go up or down right now may make little difference when you look back 10-to-20 years from now.
And for those who are more conservative? For investors who rely more on a fixed income, a portfolio that includes more cash and fixed income can smooth out the ride much better than too much equity exposure.
No matter how you approach it, there will always be bumps in the road. But diversified fixed income and cash have historically acted as shock absorbers to the equity volatility.
Finally, while we don’t know if we will get “The Santa Claus Rally” of previous years (another seasonal maxim), we do know that sticking to the fundamentals, diversifying, and sticking to a non-emotional, systematic, long-term approach, can go a long way toward helping investors reach their objectives through volatile periods.
Source: The data referenced here come from Bloomberg.
Dow Jones Industrial Average is a price-weighted average of 30 significant stocks traded on the New York Stock Exchange (NYSE) and the Nasdaq. You cannot directly invest in an index.
Past performance does not guarantee future results. Any stock market transaction can result in either profit or loss. Additionally, the commentary should also be viewed in the context of the broad market and general economic conditions prevailing during the periods covered by the provided information. Market and economic conditions could change in the future, producing materially different returns. Investment strategies may be subject to various types of risk of loss including, but not limited to, market risk, credit risk, interest rate risk, inflation risk, currency risk and political risk.
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November 26, 2018
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