The markets have been painted red. 2018 is the first year, since 2008, that large US stocks saw significant negative returns. (The total US stock market did see a very slight negative return in 2015 when we last heard whispers of a slow-down in global growth.)
Since 1926 there have been approximately 370 quarter ends of which 118 have been negative. That is about 32% of the time. The average negative quarterly return has been 7.63%; the average negative return for the twenty worst quarters in this sample has been 20.5%. As noted above, the fourth quarter of 2018 was the 20th worst at negative 14.59%. It joins the company of the bursting of the Tech Bubble, the Great Financial Crisis, Black Monday, the blowup of the Nifty Fifty and the Great Depression. This is not enjoyable company to keep. However, unlike the aforementioned twenty worst drawdowns, it does not appear we are in a recession. The real interesting question is what happens next… stocks should go up (we hope). Read on.
It is fair to say that a negative quarterly return is an infrequent event, but they most certainly occur. And, sometimes they are really bad. Volatility is the cost of admission when investing in the stock market.
A close examination of the periods above may bring back bad memories. And that’s OK. It doesn’t matter if the experience is bad as long as the behavior is right. To borrow from Rudyard Kipling, a good investor is the one who keeps their head when everyone around them is losing theirs. Investing during a period of relative strife tends to reap positive rewards. We encourage you to take advantage of the many stocks currently in a bear market (down greater than 20%).
In addition to the volatility in the fourth quarter, 2018 was a challenge because the year started out so well. Most of our managers were selling at the summer market peak and preparing to distribute large capital gains.
As we attempted to offset gains from early in the year, with losses late in the year, an action known as tax-loss harvesting, we added some new managers to portfolios. To be crystal clear, all the selling action and cash in portfolios near the end of the year is NOT because we are negative on the economy, negative on markets or negative on the current state of politics. We were selling to prevent clients from paying taxes during a year when returns went from spectacular to depressing. Most clients spent, at most, one day out of the market as we sold one investment and bought another. The goal was to stay invested with opportunistic managers that we felt confident in their ability to take advantage of the downside volatility. Unless specifically requested, most portfolios are back to being fully invested as of January 3, 2019.
Usually, the best days occur very near the worst days. They also occur randomly, making it very hard to get in and get out successfully over time, i.e., market timing does not work. According to BTN Research the US market returned 13.1% per year for the last ten years and if you missed the 10 best days, in total, your return dropped to 7.9% per year. On a starting portfolio of $100,000 missing the 10 best days lost you about $135,000 in investment gains. It is why we recommend staying in the market through all periods.
One of the new managers we added as we tax-loss harvested portfolios at year end was Ensemble Fund. They aim to invest in competitively advantaged businesses at good prices and then be patient. Indeed, they have lately commented that they salivate when a stock drops 30% and they detect no change in the fundamentals of the business. They reminded us at the end of the year that volatility acts as a blockade to rational thought. The stress of watching your assets drop in value shortens your time horizon. To quote directly from a post by a portfolio manager, Todd Wenning: “And because we feel losses more than we feel equivalent gains, there’s pain relief in selling. You don’t need to be an investing genius to conclude these moments tend to be good long-term buying opportunities. If you can hold your own nerve, that is.” We believe that this is the proper thinking and the managers at Ensemble are investing to put the odds of satisfactory returns in our favor. All of the managers in your portfolio follow the same maxim. The opportunities available today have not been apparent for most of the last 10 years.
As we conclude our commentary, a quick disclaimer is warranted. Past performance is no guarantee of future results and the future may not represent the past. Returns could become a lot worse. Do not risk money you cannot afford to lose. Nevertheless, we haven’t seen negativity like this in a long time and would think expected future returns are now higher than they were earlier this year. Emotions are high, and it can get much worse. If, after reading your account statements it feels terrible and awful, then we need to talk. But know that we are trying to keep our heads and buy bargains as we see them.