For the last few weeks, things have once again gotten a little unsettled in financial markets, so I wanted to be sure you received some information to help put some things in context and to (hopefully) add some calm to the environment.
I'm going to keep it relatively brief and visual. But first, a couple high level points to help frame what I'm saying:
1) In a few charts I reference an index (like the S&P 500) -- I realize that you almost certainly do not have a portfolio which consists of entirely of this. Yet we can use this index to derive principles about how markets and their individual constituents (both investments and investors) behave.
2) As always, past performance is not indicative of future results. I'm here to educate and help you stick with a plan that's hopefully longer term than this week, this month, or this year.
|Image #1: History of the US Stock Market, Bull vs. Bear Markets.|
This image does a great job of reminding us how much more "good" there tends to be rather than "bad."
Stock returns are volatile, that's what makes them attractive (they're more often volatile in a positive way), but nearly a century of bull and bear markets shows that the good times have outshined the bad times.
• From 1926 through March 31, 2020, the S&P 500 Index experienced 17 bear markets, or a fall of at least 20% from a previous peak. The declines ranged from —21% to —80% across an average length of around 10 months.
• On the upside, there were 17 bull markets, or gains of at least 20% from a previous trough. They averaged 56 months in length, and advances ranged from 21% to 936%.
• When the bull and bear markets are viewed together, it’s clear equities have rewarded disciplined investors.
We (investors) typically get to spend a lot more of our time feeling good rather than dealing with scary markets -- I hope this trend continues.
|Image #2: The cost of trying to tactically jump in and out of investments|
The impact of missing just a few of the market’s best days can be profound, as this look at a hypothetical investment in the stocks that make up the S&P 500 Index shows. Staying invested and focused on the long term helps to ensure that you’re in the position to capture what the market has to offer.
• A hypothetical $1,000 turns into $121,353 from 1970 through March 17, 2020.
• Miss the S&P 500’s five best days and the return dwindles to $77,056. Miss the 25 best days and that’s $26,989.
• There’s no proven way to time the market—targeting the best days or moving to the sidelines to avoid the worst—so history argues for staying put through good times and bad.
|Image #3: Worried About Recessions? Consider history...|
In the past century, there have been 15 recessions in the US. In 11 of those instances, stock returns were positive two years after the recession began.
• Investors may be tempted to abandon equities and go to cash when there is heightened risk of an economic downturn.
• But research has shown that stock prices incorporate expectations of a recession and generally have fallen in value before a recession even begins.
• The average annualized return two years after the onset of these 15 recessions was 7.8%.
• A $10,000 investment at the peak of the business cycle would have grown to $11,937, after two years on average.
Recessions understandably trigger worries. But a history of positive average performance following a recession can be a comfort for investors wondering about sticking with stocks.
|Image #4: Allocating Within a Market|
Historically, value stocks have outperformed growth stocks in the US, though recently that hasn’t been the case. While disappointing periods emerge from time to time, the principle that lower relative prices lead to higher expected returns remains the same.
• Data covering nearly a century backs up the notion that value stocks—those with lower relative prices—have higher expected returns. On average, they have outperformed growth stocks by 4.54% annually since 1928.
• But there are no guarantees, and results vary over time. Growth stocks have recently outperformed value stocks. That outperformance has been a stark departure from long‑term averages.
• While there’s no way to know where stocks are going next, value has trailed growth in the past before rebounding strongly.
Further, the chart above does not reflect 2020, which saw an enormous divide between growth and value, with US Large Growth Stocks up 38.86% (!) and US Large Value Stocks down 0.62%.
Simply put, stock markets are diverse and when one person says "we're in a bubble, a correction is coming", it is worth noting that not all segments of the market have had a euphoric, potentially unsustainable run in recent years. There may still be pockets of value.
--Data Source: DFA & Morningstar
|Image #5: Some 10 Year Forecasts|
*The above forecasts are from this attached Market Perspectives Report from Vanguard (click the link to open the report and to view important disclosures).
If you know me, then you know I'm not a big fan of predictions and forecasts. As the saying goes, "Economists have predicted 14 of the last 3 recessions."
In other words, forecasts are almost never right.
However, they can provide a decent talking point around a couple investment principles worth highlighting.
#1: If you're going to take risk, then you should want more return.
In the forecasts above, "median volatility" refers to how much fluctuation they expect within the asset class. If there's a high degree of price movement, then this figure often correlates to a high risk. The actual risk that arises with high volatility is that a price decline scares an investor into selling unnecessarily (which is linked to Risk Tolerance) or that an investor needs to sell an investment after a decline because they have to spend dollars on something (this is linked to Risk Capacity).
The important takeaway is this: volatility doesn't matter much if you have the tolerance to withstand it and the capacity to adopt it. Not everyone does have these protections, so your investment mix should reflect your unique circumstances...
#2: I believe mean reversion presents the best opportunity for Alpha
Beating the market is absurdly difficult, but not impossible. The method for pursuing this that makes the most sense, to me, is to consider portions of the investable universe with high long term historical returns, high expected returns, but low relative returns recently -- then consider highlighting those underperforming areas of the market.
Of course, this is not investment advice and it's for informational purposes only, but it should seem somewhat intuitive. In the end, you are always either early or late to a trade, which means you're probably going to feel stupid for at least a little while.
|Image #6: Post-Decline Returns|
Despite being the longest bull market for stocks in history, the last decade has had some pullbacks. The chart above highlights these, along with the subsequent 12 month rebound.
This chart does not reflect the entire post-coronavirus rally (it hasn't yet been 12 months), but by now we know the rebound was significant.
Once again, this is just some context to review how history has handled pullbacks. Past performance isn't indicative of future returns, but they're still informative.
That's all for this week, I seem to be getting a lot of questions lately about inflation and debasement of the US Dollar... I'll plan to write on that soon, but feel free to forward over any subject you're interested in and I'll do my best to dissect it.