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Three Things: The New Recession, The Jockey & Horse, and Useless Forecasting

June 19, 2020
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I hope everyone is having a great week.

Here are a few things I'd like to highlight this week: 

Thing #1: The New Recession

It's official, we're in a recession. Thanks Coronavirus....

Investors may be tempted to ditch equities and go to cash when there is heightened risk of an economic downturn. However, research has shown that stock prices incorporate expectations of a recession. Prices generally have fallen in value before a recession even begins (we saw that in February/March).

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.

The average annualized return two years after the onset of these 15 recessions was 7.8%.

A hypothetical $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.

To put things bluntly:

Don't let the onset of a recession dictate your investment strategy. Your investment strategy should have expected that recessions happen and they can be withstood. 

Thing #2: The Jockey & The Horse

Confession: I've gained a little weight during the COVID-19 lockdowns... Not a huge amount, just about 8 lbs-ish. 

Now I'm about 223 lbs and 6ft 3in. 

Why is this important?

...Because I'd make a terrible jockey if someone were trying to have me win a horse race. 

You see, even the best horse can't overcome a jockey that weighs too much and drags them down.  

Here's a sketch I made to highlight how this relates to investing: 

When investing, you have to start with a good horse.... The asset class.

Most returns in a portfolio can be explained by the fact that the portfolio had X% in stocks, Y% in bonds & Cash, and Z% in real estate. This is because most stock/bond/real estate investments are positively correlated to their overall asset class. So one of the biggest decisions investors have to make is this asset allocation

After determining the amount to put into each asset class, it's time to find a jockey to ride the horse. By now you may know that I'm not a huge fan of jockeys that try to do too much. This could be trying to engage in timing the market, trying to guess which individual securities to buy, etc... The data is clear: these are difficult and impractical ways to manage a ride. 

Most investors just need the jockey to impose the bare minimum involvement to keep the horse on track and let it run. At some point, the jockey can do more harm than good. 

Here's a YTD chart of a fund whose jockey is attempting to do their best to forecast the market. To say "it's been rough for this manager" would be an understatement.  

This fund in blue launched at the beginning of the year. It's mandate is to try to buy in and out of the US Stock Market (S&P 500) in an effort to outperform its asset class category (again, the US Stock Market). 

So far this year the fund is down 39.7% and the S&P 500 index is down 4.09% (source: Morningstar). 

This is an example of a jockey that is inefficiently riding their horse. 

But back to my COVID-19 weight gain... 

Strategies that are overly active tend to have high expenses that can drag on a portfolio. In fact, there is statistical significance that points to higher cost mutual funds being more likely to underperform. This blog post / email I sent a few weeks back covers this pretty well: 

https://www.hardingwealth.com/blog/mutual-funday

 

So here's the thing:

Even a great horse can't win a race with a bad jockey. Choose wisely. 

Thing #3: Useless Forecasts I Like to Consider

The problem with forecasting is that we have to guess what the future holds. Outside of that it's pretty easy. 


(spoiler: there is nothing outside of "that"). 


The thing about predicting financial markets, is that we not only need to predict the stimulus (i.e. the event), but also the response. 

For example, let's say I had a crystal ball and told you that Trump would be re-elected in this upcoming election...What do you think would happen?

What if I said it were definitely going to be Biden who gets elected?

... Some of my favorite influences in finance had all-but-promised a huge market correction if Trump were to win in 2016. Clearly they were wrong. 

Here's an article from Politico which spelled doom for markets if that were to happen: https://www.politico.com/story/2016/10/donald-trump-wall-street-effect-markets-230164

 

Now with all of that said, I still pay attention to what smart people are forecasting --I just take it at face value. 

Here are some recent forecasts from Vanguard: 

The above is what Vanguard is forecasting in terms of average rates of return and volatility for various stock markets over the next 10 years. It comes as no surprise that they're forecasting better returns in the segments of the market that haven't done as well in recent years (like value stocks). 

Here's what they think will happen in the bond markets: 

Clearly there's a pretty dismal outlook for returns in the bond market, but there's also less risk. Equities may have a higher expected return, but investors need to stomach volatility --2020's market thus far represent a great example of this. 

There is close to a zero percent chance that the future will play out exactly like these predictions, but that doesn't mean they're not worth considering going forward. 

But here's the primary takeaway: 

Market predictions don't relate directly to your life. 

For example, I don't know anyone who has 10 years (exactly) to invest. Even if an investor is exactly 10 years from retirement, we don't stop investing immediately when retirement starts.

Meanwhile, people are making predictions about the next month, 6 months, year, etc.. These predictions are constantly commanding our attention via articles, newscasts, CNBC, neighbors, coworkers, family members, and, yes, financial advisors like me.Ignore them all, even me (if I start making predictions).

 

That's all for today.

 

Be well, Adam

 

 

(source for these forecasts: https://advisors.vanguard.com/insights/article/marketperspectivesjune2020

 

IMPORTANT: The projections or other information generated by the Vanguard Capital Markets Model® regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results.

Past performance, including hypothetical performance, is no guarantee of future results. Investing risks include loss of principal and fluctuating value. There is no guarantee an investment strategy will be successful. Indices are not available for direct investment; therefore, their performance does not reflect the expenses associated with the management of an actual portfolio. In USD. Performance includes reinvestment of dividends and capital gains. Growth of wealth shows the growth of a hypothetical investment of $10,000 in the securities in the Fama/French Total US Market Research Index over the 24 months starting the month after the relevant Recession Start Date. Index data presented in the growth of wealth chart is hypothetical and assumes reinvestment of income and no transaction costs or taxes. Sample includes 15 US recessions as identified by the National Bureau of Economic Research (NBER) from October 1926 to December 2007. NBER defines recessions as starting at the peak of a business cycle. A business cycle is a description of the various stages of economic output. Fama/French Total US Market Research Index: The value-weighed US market index is constructed every month, using all issues listed on the NYSE, AMEX, or Nasdaq with available outstanding shares and valid prices for that month and the month before. Exclusions: American Depositary Receipts. Sources: CRSP for value-weighted US market return. Rebalancing: Monthly. Dividends: Reinvested in the paying company until the portfolio is rebalanced. Dimensional Fund Advisors LP is an investment advisor registered with the Securities and Exchange Commission. Harding Investments & Planning is a state registered RIA.