An Abrupt Stop To Bliss
As noted in the chart above, the first quarter of 2018 stopped this blissful ride. Were investors being lulled into complacency? Was the go-forward expectation that the market slopes up and to the right with unwarranted hopefulness? While some claim to hold the divining rod of the market; we do not. We find forecasting extremely hard. The best we can do is seek to understand reasonable guiderails and use those guiderails to make decisions.
We aim to calculate base rates, which are predicated on very long-term historical results. Base rates tell us what has happened and help us gauge what could happen. Base rates provide our guiderails for both action and inaction. They help us avoid complacency and help us avoid getting too high on the highs and too low on the lows. Since long-term results coalesce around a mean, base rates provide necessary guidance on how we should feel and act. To wit, over the long-term, we find we are not as stupid as we feel we are when we are out of favor and never as smart as we think we are when we are in favor. Financial market gravity – mean reversion - always brings results back to reality.
So, what do we know? We know that, from 1926, the S&P 500 has generated an average monthly total return of 0.95% with 67% of the monthly returns being between 6.34% and -4.44%. In fact, of the 1,106 monthly periods since 1926, 691 have been positive, or 62.5%. The longest historical winning streak of 15 months was achieved exactly twice 1958-1959 and 2016-2018. While company earnings follow economic growth over long periods of time and the market follows company earnings, it can be reasonably accepted that long-term, patient investors will experience positive returns. Nevertheless, there is a natural tendency to believe really good results will continue or, conversely, that really bad results will persist. Clearly, we have been in the former, an extraordinary bull market. As the old adage goes: never confuse genius with a bull market.
Our investing philosophy and research leads us to believe that long-term success comes from protecting on the downside. Toward the latter stages of bull market, we tend to fall behind as our portfolios become more conservative. We make up any short-term underperformance by protecting capital when the market drops. We add further value by investing that safe capital in periods of market stress. We have the most dissonance during those periods when the market gets most overvalued and our portfolio construction becomes more conservative. Since we never know the inflection point in advance, even the best outperforming strategies can underperform for long periods of time. In a study recently published by Morningstar titled “How Long Can a Good Fund Underperform Its Benchmark?” the authors discover that funds that ultimately outperform over a 15-year period can experience periods of underperformance for an average of 9 to 12 years. Proper investing requires equal doses of good research and an even temperament.
The preceding paragraphs can be smartly summed up in an analogy. Investing is a lot like flying in an airplane. With appropriate care and maintenance and with well-trained and skilled pilots, passengers arrive safely and on time. A flight, however, may experience light turbulence, long periods of calm and occasionally a few moments of sheer panic. At all times you should be in your seat with the seatbelt fastened because you never know when a moment of terror will arrive. If you can stay seated and prevent yourself from being thrown you will arrive safely at your destination. Despite the quick change from calm to turbulence, none of the recent volatility is out of the ordinary and is a routinely typical experience for the long-term investor.
The best investing outcomes are courses of actions, plotted in advance, unique to your needs while making little adjustments along the way. We are committed to diligent, thoughtful research as well as tolerance and patience. We want all of our clients to arrive at their individualized monetary goals safely and on time.