Hello All-
I’m writing this month’s installment from Las Vegas at a 2-day conference at the Aria Resort & Casino. After 12+ months of transitioning into the ‘independent’ world, this trip has finally afforded Evan and I the opportunity to physically meet many of our ‘new’ colleagues, and we’re reminded yet again why we made the strenuous move.
While we are now in the ‘independent’ RIA (Registered Investment Advisor) space, we are not at all alone. The RIA we have partnered with, NewEdge Advisors (initially ‘Goss’ when we first transitioned), is based in New Orleans and provides us with a massive infrastructure of top-tier support/intellectual capital (positioned all over the country) to assist us with advanced high net worth planning strategy, trading, market research, SEC/FINRA compliance, and much more but I won’t bore you.
We’ve also had an opportunity to meet a number of other ‘independent’ advisor teams just like ours, from all over the country, who have chosen to partner with NewEdge for all the same reasons we did. To quote Neil Turner & Alex Goss, the two co-founders and CEOs of NewEdge, “We are an advisor-first firm for client-first advisors.” Needless to say, it’s nice to finally be settled so we can get back to doing what we love—spending time with our clients and modeling financial plans/strategies, and now we’re able to do that stuff better than ever before.
I don’t gamble, but staying in a casino, it’s been fascinating to just sit and observe the people that really get into it. And with all the fluctuation in financial markets right now, I really got to thinking about how so many investors, especially here in America, treat the stock market like it’s a casino. I think we Americans just have a really hard time distinguishing between fluctuation and loss.
So many investors have been conditioned by financial media to automatically see a (downward) fluctuation as a loss. But in those investors’ unconscious, a couple of really bad things have happened.
First, they’ve forgotten that stocks are shares of ownership in great businesses; they’ve somehow become chips in a sort of magnificent casino game. But more to the point of this inquiry, these investors can’t tell a temporary decline from a permanent loss. The former you get all the time, and they never last. The latter you get only when you panic and sell.
Second, of course, is people's grotesque overestimation of any lasting financial damage that can be done to their retirement by ‘volatility,’ also misperceived as ‘the risk of the stock market.’ This tracks back to the fundamental inability of human nature to distinguish, during episodes of market stress, between temporary decline and permanent loss. That perceptual failure has the tragic effect of rendering permanent loss a self-fulfilling prophecy.
Major declines in stock prices are cyclical, temporary and absolutely necessary. “A bear market is a period of time during which common stocks are returned to their rightful owners.” Bull markets inflate prices to, and then beyond, what companies are really worth in the moment, then when any bit of economic uncertainty starts rattling markets, the gambling amateurs run for the hills in panic. But all value is born out of chaos. And the greatest values—the lifestyle changers, the pivot points of an investing lifetime—are born out of sheer, unreasoning panic.
The obvious solution—and what an elegant solution it would be—is simply to get out of the market somewhere near the beginning of one of these declines, and to re-enter the market rather nearer the bottom. The stark reality that no one has ever been able to consistently time both exit AND re-entry should tell you that it can’t be done. In addition to the fact that tops and bottoms are impossible to ‘call’ you have to realize that a huge percentage of the market’s gains come in the big breakaway upsurges immediately following market bottoms. Bottom line: The only way to be sure of catching all of the permanent ups is to resign yourself to riding out all of the temporary downs.
The amateurs agonize over identifying the bottom, and always miss it. As Nick Murray says “The shortest time period measurable by man is the time between when it’s ‘too soon’ to buy equities and when it’s ‘too late’”. The professionals are happy to be operating in a zone of great value (even if it’s not the very bottom), and to let nature take its course. In short, the amateur’s bear market is the professional’s big sale.
If you want the kinds of returns that equities have historically provided, you must accept the kinds of gut-wrenching declines which the equity markets have historically experienced. It’s a package deal. And since you can’t have it any other way, you wouldn’t want it any other way.
Murray: “If you’re not finished buying yet, why would you want the market to do anything but go down?” For the great mass of people who are still trying to build wealth a month at a time—wanting the market to go up is counterintuitive.
The reason to buy stocks is never what the market’s going to do next (which is unknowable to all of us anyway); it’s what the market is ultimately going to do. Stocks are ultimately going to go up more than most people are capable of imagining. So patient accumulators should always hope the next move is down.
Of course I strongly sympathize with our clients who already have everything they’re ever going to see in this world (i.e. they’re retired or about to be). They’d a heck of a lot rather that the market go up than down, and who can blame them? But, this is why we plan for these moments in advance and carefully design retiree portfolios around assets that produce a meaningful, reliable income stream. We also diversify enough such that there are ideally at least a few areas of the portfolio that have held up relatively well and could be called upon for liquidation to cover remaining lifestyle income needs.
Looking back at all of the many other moments of crisis over the past 100 years, no one could say how or when those crises would be resolved—as you’ll see by looking at the free-falling chart of stock prices during those days.
The truth is, once you’ve accepted that there’s no real way both to enjoy equities’ long-term return and to avoid the significant temporary price declines, you’re free to choose the way you process the experience of those declines. You can try to figure out when and why a decline will end---that way lies anxiety, confusion, anger, fear, and capitulation—right at the bottom. Alternatively, you can profess serene and total ignorance of when and why a decline will end, because you possess something much more valuable: the unshakable faith that it will end.
Knowledge of the future is always unavailable, most maddeningly so in times of great crisis. Faith in the future is limitlessly available---even journalism can’t take it away from you if you refuse to give it up.
Speaking of Journalism. Journalism:
- Always gets it wrong
- Manifests a relentless bias toward the negative (which we are ABSOLUTELY seeing unfold right now)
We are going to hear more about unemployment as a result of rate hikes. And the media is going to have a field day with any little bit of an uptick. But if we take a step back—unemployment is at a 40-year low and it’s going to take a lot to change that (yes, even with these hikes!). When unemployment reached 8.9 million in January 1992, journalism shrilly announced that the number of people out of work was at its highest since 1983. This was narrowly true, but meaningless: the labor force had grown by about 14 million people in the interim.
In addition to its inherent negativity, journalism’s very short time horizon, is the enemy of all truth about investing, which is long-term. The closer you get to the markets, the more facts you’re deluged with, and the less truth you see. It isn’t journalism’s job to make people good investors. It’s their job to keep people coming back for more journalism. And since bad new is good copy, you’ll always see a lot of bears in article thumbnails right at the bottom of the market.
I recently came across a fascinating piece of financial journalism- it was Business Week’s classic ‘The Death of Equities’ cover article (subtitled ‘How inflation is destroying the stock market’). It appeared on August 13, 1979—a day on which the Dow closed at 875.26—and said (among numerous other gems), “For better or worse, then, the US economy probably has to regard the death of equities as a near-permanent condition…” If you didn’t know that the biggest bull market of all time was on the horizon before August 13, 1979, you certainly could have known it when you’d finished reading that howler.
To avoid this becoming too long, I’m just going to bullet out a few other important points that I feel are important to consider as you try to get a better read on what’s going on right now, how we got here, and how we’re going to come out of it:
- Central banks around the world were caught flat-footed earlier this year with respect to the inflation problem. They got it wrong in 2021, and kept interest rates ultra low, labeling the inflation issue ‘transitory’, believing with good reason that it was perhaps only short-term as the economy wasn’t yet prepared (with enough supply of ‘stuff’) for the post-covid spike in demand for pretty much everything, especially in the services sector.
- Despite my preaching the contrary, it would be valid for any of you to point out that I have gone along with this (the Fed’s) view and attempted to prognosticate in various distributions over the last ~18 months, suggesting that it was quite likely that inflation would start to soften more significantly, and soon.
- I was wrong. While inflation has softened slightly, the CPI reading for August was 8.3% (cooling only slightly from the June high of 9.1%).
- So now the Fed (and most other major central banks around the world) are serious. Until they see inflation data go down, they’re going to keep ratcheting up interest rates. They are deliberately trying to cut demand for goods and services by making it more expensive to finance them. The idea is that reduced demand for these goods and services will ultimately result in cooling prices.
- Especially with this most recent rate hike, there is now a more considerable risk that the Fed could overshoot their target (keep rates higher longer than necessary to reduce demand/prices/inflation) and cause a painful recession. But they are still right in doing this, as inflation left unchecked would otherwise cause a catastrophic recession down the line.
- Paradoxically, the statistics below are likely to insulate the American economy from any significant recessionary shocks, but at the same time, pose a bigger risk of dragging out the contagion of inflation. So Fed needs to go big.
- Still $2 trillion in excess savings sloshing around in American household bank accounts
- Unemployment rate remarkably low @ 3.7%
- The economy has added an average of 380,000 jobs monthly over the past six months, far above the rate of about 50,000 that economists think would keep the unemployment rate steady (don’t want it lower)
- Median labor market earnings in America have risen by ~7%
- Despite some revision, corporate earnings expectations still solid
- But until we have a better idea of the trajectory of inflation, financial markets are going to continue to be turbulent. So I do think that it’s fairly possible that we re-test the stock market lows (for 2022) in June.
- As I’ve mentioned in previous distributions, the market is forward looking- it’s always looking 6-18+ months ahead. If we are ultimately ‘hit’ by an official recession, the market will likely have already moved past it and will be rebounding at that time. 2020, during covid, is a good example. The economy contracted 20%, but only for 2 quarters, and the market was already ‘over it’ and soaring again, even though we were still in the ‘eye of the storm’.
- I think it’s worth noting (with one major caveat being that today’s inflation is NOT AT ALL the same as that which we experienced in the 70s and early 80s) that once it was clear that Volcker’s policies were working in those years, and inflation was showing the earliest signs of meaningful cooling, the market soared and fully recovered ALL of its prior losses in only 4 months. Even though the recession technically continued over that stock market recovery period.
- Also previously mentioned, even with heightened risk of further decline in the short-term, I do not feel that selling is sensible. The market is going to fall as far and as fast or slow as is necessary, for the sake of stamping out inflation.
- Worth reiterating is that this moment of high inflation shows us that stocks are the only true long-term hedge against inflation (average annual return on S&P ~10%). When you look at the long term average yields on bonds, they’re only about half of the current inflation rate. So even with rising yields right now, bonds aren’t going to be our savior, thus, we don’t recommend any meaningful pivots in that direction.
- Instead, we should focus on making sure we continue to own quality businesses (that are likely best positioned for rebound). And making sure that our retiree clients are reminded that we have an income plan for them.
- While we are feeling the most pain in US large cap growth companies, as well as US small & mid cap companies we still feel very strongly that the current weightings should be maintained. Remember that, unless you blow your life savings at a casino (as I’m sure could be happening right now just feet away from me), a considerable portion of your portfolio will not need to be accessed for 5-10+ years. So we should still be invested with a growth objective for a meaningful portion of your assets.
- For more perspective on how to develop a healthier view of the stock market in times like these, here is Nick Murray’s September ‘Client’s Corner’ piece titled “How to Think About ‘The Stock Market’”.
- Also, check out this chart showing the ‘Bumpy Road To Long Term Average’. Key points:
- Since 1926, the US stock market has rewarded investors with an average annual return of about 10%. But it’s important to remember that returns in any given year may be sky-high, extremely poor, or somewhere in between.
- Annual returns came within two percentage points of the market’s long-term average of 10% in just seven of the past 96 years.
- Since 1926, annual returns have been positive 71 times and negative 25 times.
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Lastly, on the topic of inflation, The Capital Group summarizes the important considerations here in 'Is high inflation the ultimate pandemic distortion?'
“Things in life will not always run smoothly. Sometimes we will be rising toward the heights—then all will seem to reverse itself and start downward. The great fact to remember is that the trend of civilization itself is forever upward; that a line drawn through the middle of the peaks and valleys of the centuries always has an upward trend.”
-Reverend Endicott Peabody, headmaster of Groton, quoted by his former student, FDR in FDR’s last inaugural address January 20, 1945.
Even as FDR’s life drew rapidly to its close, with the war in Europe still dragging on—his thoughts returned to a boyhood lesson in faith in the future.
Dr. Peabody’s permanent uptrend line “drawn through the middle of the peaks and valleys of the centuries” is mirrored in the long-term behavior of stock prices. And it is the permanent upward bias of the trendline, not the often jagged slopes between peaks and valleys, that most concerns us. If one has faith in the trendline, the peaks and valleys can be put to very advantageous use. (While without faith in the trendline, the investor will sooner or later give way to panic, which will result in permanent devastation.)
With the 24-hour, negatively biased news cycle today, it is only human to feel like this moment of doom and gloom is the end of prosperity and progress as we know it (the same feeling that so many generations of humans/investors before us have inevitably felt at more trying moments in history), but it is not. We have overcome several devastating wars over the past century. We have also overcome several periods of sky-high inflation. Triumph over those is a given. But even with climate change as a new and seemingly ever-worsening threat---this is not the end of the upward trendline of prosperity and progress. Even if we lose New Orleans and Miami, as unfathomable as that is to even think about. Sadly, disasters of that magnitude may be the wake up call we collectively need to ultimately come together to seriously combat the issue. But our 2022 minds can’t even currently comprehend the future innovation that will arise when climate crisis is finally taken seriously and remediation given proper funding, and how that innovation will sustain the trendline.
All of this to say---loss aversion is a very common cognitive bias. When you’re seeing your life savings fluctuate 20-30% in the downward direction, it’s only human for the nervous system to react and go into ‘fight or flight’. But human nature is a failed investor. In these moments, try to remember this stress-reducing mantra: no panic, no sell; no sell, no lose.
I promise to invest your capital as carefully as I do my own (and my family’s), because I know that your hopes for your family’s future are every bit as sacred to you as mine are to me.
-Charlie
