I was out at dinner over the weekend with a group of friends and the topic of financial markets came up. “Are your clients really worried about the share market?”, I was asked. “Not really”, I responded. My response was foreign to her. She was shocked that the stock market’s decline of about 8% over the last couple of weeks hadn’t shaken our clients. “What do you mean, not really? We haven’t seen a decline like this for a long time, the stock market is at it’s peak, the US are raising interest rates, Trump is ruining global trade, and China is slowing down”.
I believe that over the long-term markets are driven by fundamentals, and over the short-term, sentiment. The recent events have investors asking how much further will the market fall, and whether this is the start of a bear market.
Here’s what the recent market decline looks like since (chart since June this year):
Source: Yahoo Finance
And here’s a longer-term perspective. I’ve highlighted the most recent decline as well as similar declines we’ve seen over the last few years:
Source: Yahoo Finance
It’s been 10 years since the GFC, and the stock market has gone bonkers since. In fact, it’s the second longest bull market in history, with a gain of almost 325% (S&P500). Let’s all now look forward to the next bear market and it’s benefits.
1. The Greatest Gift
It’s one of the greatest financial gifts that may be offered to you, but only if you accept it. What do I mean by that? It is only rewarding if you do something about it, that is, if you continue to invest – because you’re buying assets at a lower price. It gives you the opportunity to leapfrog your wealth in such a short-period of time.
This is what a Black Friday sale looks like in the US. For those of you who don’t know, Black Friday is basically the first day of the Christmas shopping season, and everything is ridiculously cheap.
Here’s what folk do when the stock market is ridiculously cheap.
2. Your Risk Tolerance
Fred Schwed wrote the celebrated 1940 book about Wall Street, “Where Are the Customers’ Yachts?” In it, he offers this memorable passage: “Like all of life’s rich emotional experiences, the full flavor of losing important money cannot be conveyed by literature. You cannot convey to an inexperienced girl what it is truly like to be a wife and mother. There are certain things that cannot be adequately explained to a virgin by words or pictures.”
There’s no way to know ahead of time, how we’ll feel and act during the most turbulent of times. While things are going well investors will typically allocate more money to this asset class – it’s the classic buy high, sell low strategy. The most important decision investors can make is how much they will allocate to different asset classes – their asset allocation, which dictates 90% of your return with stock selection and market timing making up the rest.
Mr. Markowitz was then working at the RAND Corporation and trying to figure out how to allocate his retirement account. He knew what he should do: “I should have computed the historical co-variances of the asset classes and drawn an efficient frontier.” (That’s efficient-market talk for draining as much risk as possible out of his portfolio.)
But, he said, “I visualized my grief if the stock market went way up and I wasn’t in it — or if it went way down and I was completely in it. So I split my contributions 50/50 between stocks and bonds.” As Mr. Zweig notes dryly, Mr. Markowitz had proved “incapable of applying” his breakthrough theory to his own money. Economists in his day believed powerfully in the concept of “economic man”— the theory that people always acted in their own best self-interest. Yet Mr. Markowitz, famous economist though he was, was clearly not an example of economic man.
Living through a bear market is really the true way of discovering what mix between stocks and bonds we’re most comfortable with.
Ben Carlson summed it up perfectly in a recent tweet:
Watching stocks rise 400% since 2009:
“I’m a long-term investor who ignores the short-term noise.”
Watching stocks fall 8% in a month:
“I’m watching the 272-day moving average very closely here. That level breaks and watch out below.”
— Ben Carlson (@awealthofcs) October 24, 2018
3. A Necessary Detox
Bear markets are a necessary detox to the foolishness of euphoria. They’re a neat way of weeding out the not so long-term investors – an ugly way to do, but one that is necessary.
Bull markets are born on pessimism, grown on skepticism, mature on optimism and die on euphoria.
– Sir John Templeton
Although it’ll dent your portfolio in the short-run, it’s much better for you long-term.
Morgan Housel’s tweet was a knock out:
— Robert Baharian (@RobertBaharian) October 26, 2018
With the right mix of assets, a bit of cash under the mattress, investments that have specific objectives, and someone to guide you along the way, you too wouldn’t be worried about the next bear market.
Source: Ben Carlson – A Wealth of Focus, Market Watch, Yahoo Finance, Giphy, Investopedia, NY Times