History and Presidential Elections

What History Tells Us About US Presidential Elections and the Market

It’s natural for investors to look for a connection between who wins the White House and which way stocks will go. But as nearly a century of returns shows, stocks have trended upward across administrations from both parties.

Stocks have rewarded disciplined investors for decades, through Democratic and Republican presidencies. It’s an important lesson on the benefits of a long-term investment approach.

Shareholders are investing in companies, not a political party. And companies focus on serving their customers and growing their businesses, regardless of who is in the White House.

US presidents may have an impact on market returns, but so do hundreds, if not thousands, of other factors—the actions of foreign leaders, a global pandemic, interest rate changes, rising and falling oil prices, and technological advances, just to name a few.

The anticipation building up to elections often brings with it questions about how financial markets will respond. But the outcome of an election is only one of many inputs to the market. Below is a link to an interactive exhibit that examines market and economic data for nearly 100 years of US presidential terms and shows a consistent upward march for US equities regardless of the administration in place. This is an important lesson on the benefits of a long-term investment approach.

Follow this link to learn more about each presidency:   Interactive Exhibit - Markets Under Each Presidency

As always, we are here to help.

Best,

CAM Investor Solutions

Source: In US dollars. Stock returns represented by Fama/French Total US Market Research Index, provided by Ken French and available at http://mba.tuck.dartmouth.edu/pages/faculty/ken.french/data_library.html; US Government Presidential and Congressional data obtained from the History, Art & Archives of the United States House of Representatives. US Senate data is from the Art & History records of the United States Senate; Federal surplus or deficit as a percentage of gross domestic product, inflation, and unemployment data from Federal Reserve Bank of St. Louis (FRED). GDP Growth is annual real GDP Growth, using constant 2012 dollars, as provided by the US Bureau of Economic Analysis. Unemployment data not reported prior to April 1929; Dimensional Fund Advisors; M & A Consulting Group, LLC, doing business as CAM Investor Solutions is an SEC registered investment adviser. As a fee-only firm, we do not receive commissions nor sell any insurance products. We provide financial planning and investment information that we believe to be useful and accurate. However, there cannot be any guarantees. This blog has been provided solely for informational purposes and does not represent investment advice or provide an opinion regarding fairness of any transaction. It does not constitute an offer, solicitation or a recommendation to buy or sell any particular security or instrument or to adopt any investment strategy. Any stated performance does not reflect the expenses associated with the management of an actual portfolio. Past performance is not a guarantee of future results. Diversification does not eliminate the risk of market loss. Charts and graphs provided herein are for illustrative purposes only. There are many different interpretations of investment statistics and many different ideas about how to best use them. Nothing in this presentation should be interpreted to state or imply that past results are an indication of future performance. Tax planning and investment illustrations are provided for educational purposes and should not be considered tax advice or recommendations. Investors should seek additional advice from their financial advisor or tax professional.

Should I Be Buying or Selling Stocks Now

It seems investor sentiment has quickly changed since the beginning of the year, not to mention from just about 10 days ago as witnessed by the recent stock market decline. Many argue "why" this has happened and here's a quick look at the potential reasons:

Coronavirus: Most argue this is the primary reason for the recent market sell off. Its certainly terrible what is happening across the globe to humans who are suffering or have passed away. Our hope is that we have containment and a cure soon.

Presidential Election Uncertainty: Others will point to the future expectation being priced in on who will win the next election based on recent debates. We won't go here, especially because the market will figure it out faster and price it in before any of us can profit from the future results.

"We were due for a correction"Always a classic reason for market sell offs, especially coming off all-time market highs just a couple of weeks ago.

Insert your own "crisis of the day": We are adding this one in advance of what will happen in 2020 and beyond. We don't know what the next crisis will be or when, but its highly probable that it will be something we can't control or predict.

Who should be concerned? Its simple: those who have not put a good financial plan in place. For those of you who have taken the time to establish a well thought out financial plan, you've been planning for short-term market fluctuations like this which will have no impact on your current or future lifestyle. For the latter audience, it is also probable that you and/or your advisor are rebalancing your portfolio given the opportunity. This is how risk is properly managed and how investors build a larger nest egg over time. It is also what we call investor discipline, but we know its not always easy to watch depending on your stage of life.

Chart end date is 12/31/2019, the last trough to peak return of 451% represents the return through December 2019. Bear markets are defined as downturns of 20% of greater from new index highs. Bull markets are subsequent rises following the bear market trough through the next new market high. The chart shows bear markets and bull markets, the number of months they lasted and the associated cumulative performance for each market period. Results for different time periods could differ from the results shown. Past performance is no guarantee of future results. Indices are not available for direct investment; therefore, their performance does not reflect the expenses associated with the management of an actual portfolio. Source: S&P data © 2020 S&P Dow Jones Indices LLC, a division of S&P Global. All rights reserved.

In light of recent investor questions, market volatility, lower interest rates, and lower inflation expectations, we thought we would leave you with some additional food for thought as you might be considering rebalancing and/or different investment strategies going forward. And of course beware of those trying to sell you the "guaranteed" products that are not a fit. These folks seem to be everywhere at a time like this.

Investment Strategy Considerations/Risks:

PASSIVE FIXED INCOME

Many investors use the Barclays Agg as a proxy for the fixed income universe. The Barclays Agg has no TIPs, 28% of the index is short volatility and 32% has credit spread risk. Some larger, well-known mutual funds hold this type of risk.

REAL ESTATE

While rates are extremely low, any jump in higher rates increases the all-in cost of buying a home or other property, which can depress demand. Increased rate volatility can reduce mortgage lenders' appetite for new loans.

MINIMUM VOLATILITY / LOW VOLATILITY STOCKS

Min vol / low vol stocks can be seen as "defensive" and used with the goal to generate yield with less equity risk than the broader market. However, investors might be overpaying for "safe" stocks. These stocks have nothing to do with owning "volatility".

SHORT DURATION BONDS / TIPS

TIPS are set using the Consumer Price Index (CPI), which only represents today's inflation level.

FLOATING RATE NOTES (FRN)

Frequently used to profit from higher yields, FRNs may have credit risk and almost no sensitivity to interest rates. Currently 91% of the bonds trading in the Bloomberg Barclays Floating Rate <5 Year Index are trading above par.

PRIVATE ALTERNATIVE INVESTMENTS

While some private alts may serve as a good diversifier, caution is recommended as most strategies in this arena perform just like the stock market with a lag in reporting. Not to mention, most are super expensive, over-leveraged, and illiquid.

EQUITIES / GLOBAL STOCKS

Global Equities are a very efficient and low cost way to gain exposure to the capital markets. They can also serve as a way to keep pace with inflation over time. Given their risk/return characteristics, global equities are subject to market sell-offs due to deteriorating economic conditions.

Of course, there is a lot more to consider given investor needs, circumstances, and risk tolerance. Having a well-designed plan can address most all of these concerns and uncertainties. 

As always, we are here to help.

Cheers,

CAM Investor Solutions

Source: S&P data © 2020 S&P Dow Jones Indices LLC, a division of S&P Global. All rights reserved; Bloomberg; Dimensional Fund Advisors; Nancy Davis, Quadratic Capital Management, LLC; M & A Consulting Group, LLC, doing business as CAM Investor Solutions is an SEC registered investment adviser. As a fee-only firm, we do not receive commissions nor sell any insurance products. We provide financial planning and investment information that we believe to be useful and accurate. However, there cannot be any guarantees. This blog has been provided solely for informational purposes and does not represent investment advice or provide an opinion regarding fairness of any transaction. It does not constitute an offer, solicitation or a recommendation to buy or sell any particular security or instrument or to adopt any investment strategy. Any stated performance does not reflect the expenses associated with the management of an actual portfolio. Past performance is not a guarantee of future results. Diversification does not eliminate the risk of market loss. Charts and graphs provided herein are for illustrative purposes only. There are many different interpretations of investment statistics and many different ideas about how to best use them. Nothing in this presentation should be interpreted to state or imply that past results are an indication of future performance. Tax planning and investment illustrations are provided for educational purposes and should not be considered tax advice or recommendations. Investors should seek additional advice from their financial advisor or tax professional.

The Great Market Plunge of 2019

It was in this letter exactly a year ago that we sought to provide some perspective about the steep decline stocks had just experienced in fourth quarter 2018. Over the course of just a few trading sessions in December, the Dow Jones Industrial Average declined 12%, and the Russell 2000 small stock index fell 14%. The plunge sent the major market benchmarks into bear market territory (defined as a decline of 20% or more) for the first time in a decade.

The anxiety in the market was apparent heading into 2019. Despite that, we urged calm and caution:

The thing about moving to the perceived safety of less volatile investments like bonds and cash during a downturn is that, once the dust clears and the market turns up again, it usually turns up in a big way. Much of the recovery happens before most investors realize it, and big gains that were there for the taking by those who are fully invested are missed by those sitting on the sidelines.

-- CAM Investor Solutions client letter, January 2019

As it turned out, that is exactly what transpired in 2019. Stocks across the globe went on a tear, posting gains well into double-digits. All of the damage done by the 2018 bear market was wiped away as market benchmarks closed 2019 at or near record highs:

This isn’t to suggest that we had any divine insight about when stocks would recover. Sometimes bear markets come and go quickly, as this one did. Sometimes they are plodding and protracted, as the 1973-74 bear market was. And sometimes they are unnerving and traumatic, as the 2008-09 bear market proved to be.

The one constant in all of these examples, though, is that they all ran their course over time. There has never been a bear market that didn’t end eventually, and invariably the market surges upward when the dust has cleared. That’s what happened in 2019.

Predictably, the market doom-and-gloomers have changed the narrative and now are trying to convince us that stocks are too high. They point to the fact that the Dow has climbed from 6,470 in March 2009 to its present level (as of this writing) north of 29,000. Given that, it’s easy fodder for the talking heads to make the case that stocks are destined for a downturn.

It’s interesting, then, to look at the stock-market performance of this past decade compared to prior decades. When we do, we find that the strong performance of the 2010s was hardly out of the ordinary:

Clearly, the strong performance of stocks in the past decade doesn’t necessarily portend a big downturn on the horizon. But still the doom-and-gloomers appear on our TV screens and on our apps and computers to warn us things are just about to fall apart. Whether they are economists, hedge-fund managers, or former government officials, these perma-bears all sing from the same side of the hymnal: Something is fundamentally wrong with the economy/financial system/stock market and imminent doom awaits us all.

Interestingly, a recent study finally took some of the more high-profile perma-bears to task. The study dubbed them the “Armageddonists” and took a look at what the impact on a dollar would have been during the 2010s if an investor followed their advice to flee stocks and move to bonds:

The damage done to an investor who followed the Armageddonists’ advice is staggering. Even the “best” performer of this group saw a 25% underperformance compared to the S&P 500. Most of the group saw underperformance in the range of 30% to 60%.

Alas, this is not anecdotal. Individual investors have proved susceptible to the Armageddonists time and time again, and 2019 was no different. Individual investors fled stocks in droves throughout 2019, even as stocks surged upward along the way. A December article in The Wall Street Journal reported that:

Investors have pulled $135.5 billion from U.S. stock-focused mutual funds and exchange-traded funds so far this year, the biggest withdrawals on record, according to data provider Refinitiv Lipper, which tracked the data going back to 1992…Investors have put roughly $277.2 billion into U.S. bond funds so far this year, the third biggest sum over the past decade, while $482.8 billion has flowed into money-market funds, an 11-year high, according to Refinitiv.

-- Investors Bail On Stock Market Rally, Fleeing Funds at

Record Pace, The Wall Street Journal, December 8, 2019

It's both predictable and sad that individual investors react this way to market volatility. There’s little rational thought behind such behavior; it’s all based on emotion – specifically fear – as they become overwhelmed with negative information and opinions, much of it designed to spur exactly that kind of panicky behavior.

These are the dangers of letting emotions and hunches drive your investment strategy. What do investors who fled stocks in 2019 do now in 2020, with stocks back near record highs? If they jump back into equities and happen to catch another downturn, they will have essentially double-dipped on the downside. And if they wait until the next downturn comes, they will more than likely convince themselves, yet again, that such a downturn is no time to be investing in stocks. This is the dilemma of market timing – never knowing what to do and always being afraid you’ll make the wrong move no matter the market environment. It’s no way to manage an investment portfolio, and it may be a path to financial disaster. The better path is to let your financial plan drive your investment strategy.

As always, we are here to help.

Best,
Marc

Source: LPL Research; Bloomberg; Ned Davis Research; Axios Visuals; JP Morgan Asseet Management; Capital Directions, LLC; Wall Street Journal December 8th, 2019 "Investors Bail on Stock Market Rally, Fleeting Funds at Record Pace"; M & A Consulting Group, LLC, doing business as CAM Investor Solutions is an SEC registered investment adviser. As a fee-only firm, we do not receive commissions nor sell any insurance products. We provide financial planning and investment information that we believe to be useful and accurate. However, there cannot be any guarantees. This blog has been provided solely for informational purposes and does not represent investment advice or provide an opinion regarding fairness of any transaction. It does not constitute an offer, solicitation or a recommendation to buy or sell any particular security or instrument or to adopt any investment strategy. Any stated performance does not reflect the expenses associated with the management of an actual portfolio. Past performance is not a guarantee of future results. Diversification does not eliminate the risk of market loss. Charts and graphs provided herein are for illustrative purposes only. There are many different interpretations of investment statistics and many different ideas about how to best use them. Nothing in this presentation should be interpreted to state or imply that past results are an indication of future performance. Tax planning and investment illustrations are provided for educational purposes and should not be considered tax advice or recommendations. Investors should seek additional advice from their financial advisor or tax professional.

We Struggle to Act Responsibly

It’s no surprise that people often struggle to act responsibly, even when they know better. They charge too much on their credit cards, eat ice cream for breakfast and skip the gym. Many of these self-control issues are driven by present bias, which is the tendency to make choices that are distorted by the prospect of an immediate reward. Here are two sample questions from a behavioral test capable of measuring an individual’s level of present bias:

Question 1: You just learned that you are due a tax refund. If you’d like, you can get the $1,000 refund right away. Alternatively, you can get a $1,100 refund in 10 months. Which do you prefer?

Question 2: You just learned that you are due a tax refund. If you’d like, you can get a $1,000 refund in 18 months. Alternatively, you can get a $1,100 refund in 28 months? Which do you prefer?

The two questions are nearly identical. However, the second question postpones the two options by 18 months, while the first offers an option for an immediate reward. Someone at low risk of present bias should answer both questions the same way: choosing the early option both times, or the delayed option both times. In contrast, those at high risk of present bias choose inconsistently. They will take the larger tax refund if both refunds require a delay, as in the second question. But they choose to accept the smaller amount when it is available immediately, as it is in the first question. For these people, the prospect of getting an immediate reward is simply too difficult to resist.

Present bias can shape many of our most important financial decisions. Just look at the timing of retirement. Research has shown that the extent of present bias predicts an individual’s risk of retiring too early and regretting that decision. Fortunately, investors and professionals can use this present bias test to minimize the risk of future regret. While early retirement might be tempting, it is important to understand the dangers of retiring too early and regretting it, whether it’s because investors haven’t saved enough or because they’ll get bored playing golf. In addition, investors high in present bias can be encouraged to save at a slightly higher rate during their working years. That way, if these investors are tempted to retire early, they will at least have sufficient resources. One of the jobs of a financial planner is to help clients avoid major financial mistakes. The best way to do that is to anticipate their future regrets and make sure they never happen.

NARROW FRAMING TEST

Many of the financial mistakes people make are caused by a fundamental shortcoming:  They can’t see the big picture. In behavioral economics, this is known as “narrow framing.” When it comes to asset allocation, narrow framing means that many investors will make investment decisions without considering the context of their overall portfolios or relevant time horizons. This test measures whether or not investors display an inconsistency in responding to a series of monetary outcomes when they are framed narrowly or broadly. Those who display the inconsistency are at higher risk of narrow framing, which can lead to serious investing mistakes, especially when it comes to the assessment of risk. Here’s a sample mistake caused by narrow framing: Some investors tend to myopically focus on short-term losses. Instead of considering how an investment fits with their long-term goals (for example, a comfortable retirement), investors get scared by the daily swings of the market. As a result, they opt for an excessively conservative portfolio or keep too much of their assets in cash. In this case, a financial planner can tailor the communication strategy to highlight an investor's long-term returns and the minimal impact of short-term fluctuations.

In other cases, narrow framing can lead people to take on too much risk. This is typically because they don’t realize they have similar investment risks in different investment accounts. One solution to this problem is to encourage account aggregation. The problem with having multiple accounts at different firms is that it can make it harder for investors to think holistically about their finances and properly assess their overall risk exposure. By engaging investors with the narrow framing test, financial planners can help them understand the benefits of having a single view of all of their accounts. If investors or professionals want to truly understand their financial reality, then it needs to be easy for them to see the big picture.

If you don't have a good plan in place, it may be time just to give you a little more confidence and conviction so you too can avoid some of these common issues investors face. As always, we appreciate our relationship with you, and we are here to help.

Cheers,

Marc

Source: Philipp Schreiber and Martin Weber, “The Influence of Time Preferences on Retirement Timing,” SSRN, 2016; Amos Tversky and Daniel Kahneman, “The framing of decisions and the psychology of choice,” Science, 1981; Nicholas Barberis, Ming Huang and Richard H. Thaler, “Individual preferences, monetary gambles, and stock market participation: A case for narrow framing,” American Economic Review, 2006; Shlomo Benartzi and Richard H. Thaler, “Myopic loss aversion and the equity premium puzzle,” The Quarterly Journal of Economics, 1995; Shlomo Benartzi and Richard H. Thaler, “Risk aversion or myopia? Choices in repeated gambles and retirement investments,” Management Science, 1999 Uri Gneezy and Jan Potters, “An experiment on risk taking and evaluation periods,” The Quarterly Journal of Economics, 1997; Shlomo Benartzi and Richard H. Thaler, “Risk aversion or myopia? Choices in repeated gambles and retirement investments,” Management Science, 1999; WisdomTree. M & A Consulting Group, LLC, doing business as CAM Investor Solutions is an SEC registered investment adviser. As a fee-only firm, we do not receive commissions nor sell any insurance products. We provide financial planning and investment information that we believe to be useful and accurate. However, there cannot be any guarantees. This blog has been provided solely for informational purposes and does not represent investment advice or provide an opinion regarding fairness of any transaction. It does not constitute an offer, solicitation or a recommendation to buy or sell any particular security or instrument or to adopt any investment strategy. Any stated performance does not reflect the expenses associated with the management of an actual portfolio. Past performance is not a guarantee of future results. Diversification does not eliminate the risk of market loss. Charts and graphs provided herein are for illustrative purposes only. There are many different interpretations of investment statistics and many different ideas about how to best use them. Nothing in this presentation should be interpreted to state or imply that past results are an indication of future performance. Tax planning and investment illustrations are provided for educational purposes and should not be considered tax advice or recommendations. Investors should seek additional advice from their financial advisor or tax professional.

Don't Just Sit There - Do Something

It has been said that golf is an easy game, it’s just hard to play. Much the same could be said of investing.

The principles of long-term investment success aren’t particularly complicated. Construct a well-diversified portfolio appropriate for your risk and return needs. Stay the course and let compounding work its magic over time. Easy, right?

And yet…it isn’t. Emotions get the better of investors. Fear and greed are constantly whispering in their ear. They worry about the downturns and second-guess themselves in the upturns, wondering if they are doing the right thing. They can’t avoid the temptation to make “adjustments” and “tweaks” to their portfolio based on short-term market trends. They sit on cash that should be invested, worrying that the market is too high or too low.

Avoiding these temptations is made infinitely more difficult in our modern world. Every time investors pick up their phone or turn on the TV, they are bombarded with a firehose of information, much of it worrisome. The spin may change depending on the day, but the underlying message from the “experts” is always the same: Don’t just sit there – do something!

This message seems to peak whenever October rolls around, and we are seeing it again this year. Stories abound about the so-called “October Effect” – the (supposed) tendency for stocks to experience declines more frequently and more severely in October than the other months of the year. The pundits make competing predictions about which sectors investors should overweight or underweight and how much cash to raise to protect against a downturn.

These pundits might find it an inconvenient truth that October isn’t the worst month historically for frequency of stock declines; that distinction actually belongs to September. What is true about October is that it is historically the most volatile month of the year and has a higher standard deviation than any other month on the calendar. Given that three of the biggest stock-market percentage declines of all time have occurred in October (1929, 1987 and 2008), it isn’t a big surprise that investor anxiety rises when the pumpkins hit the stores. The historical spike in volatility in October is a reflection of that anxiety. 

But even accepting that October is historically the most volatile month of the year for stocks, the question remains: What should long-term investors do with that information?

There are two important things to keep in mind about volatility, regardless of how October 2019 – or any other month – plays out for stocks:

Volatility is a necessary component of stock investing

Investors demand more upside when they take on more risk. Cash has lower volatility and therefore lower expected returns than bonds. Bonds have lower volatility and lower expected returns than stocks. Large stocks have lower volatility and lower expected returns than small stocks. And on and on. There is simply no way around the risk/reward equilibrium. Risk and return are related. If volatility wasn’t an inherent part of stock investing, investors wouldn’t reap the higher expected returns that stocks generate over bonds and cash. While living with the short-term ups-and-downs that are a part of stock investing isn’t fun, it is the medicine we must take to obtain the higher long-term returns we will need to protect our purchasing power against inflation.

Volatility becomes much less of a factor over time

If the price of your house declines by 20%, do you rush to sell it before the value drops even more? Most homeowners would never take such rash action, and yet every time the stock market goes into a steep decline we see large numbers of equity investors run for the exits. Some of this is attributable to the liquidity of stocks compared to real estate; it isn’t possible to bail out of your house at the push of a button, but it is possible to do that with your stock portfolio. But it also speaks to the lack of a long-term view many investors have about stocks. Homeowners expect to be in their houses for the long term and don’t worry about the short-term fluctuations, but they don’t take a similarly sanguine view with their stock portfolio.

After the market crash of October 1929, the Dow Jones Industrial Average stood at 230. The Dow fell to a level of 1,738 after the October 1987 plunge, and it fell to 8,451 on October 10, 2008 after the initial selloff during the Financial Crisis bottomed out. And yet here we are today, with the Dow (at present) hovering around the 26,000 level. The undeniable reality is that stocks have overcome every downturn they have ever experienced – given enough time.

Alas, while stock volatility isn’t an issue over the long run, most stock investors don’t stay invested long enough to let it runs its course. The 2018 Quantitative Study of Investor Behavior by Dalbar & Associates found that the average holding period for an equity mutual fund from 1998-2017 was just 3.55 years! There is a significant opportunity cost that investors – especially taxable investors – incur when they constantly move their money from fund to fund, or in and out of the market. Transaction costs, taxes and just plain bad guessing all add up to deny investors the returns that were there for the taking if they had just stayed put. We can see the cost of this behavior in the following chart comparing the average annual returns of equity-fund investors to the S&P 500 over the past decade (source: Dalbar & Associates QAIB Study 2018):

It is a sad reality that the average equity-fund investor attained the equivalent of bond-fund returns over the past decade. Clearly, behavior is a major component of investment success and is the one factor that gets the least amount of attention. This is why having a disciplined investment management plan and sticking to that plan regardless of short-term market conditions will have the biggest impact on your long-term wealth.

To take it a step further, if you have a well thought out financial plan in place or have established a very efficient retirement income strategy, then all the short-term noise should have no impact on you. This is because you have already planned for market volatility, recessions, and bear markets due to how you are managing risk. You likely also understand how to get properly compensated for taking the right investment risks.

If you don't have a good plan in place (above and beyond just picking investments), it may be time just to give you a little more confidence and conviction as you tune out all the noise. As always, we appreciate our relationship with you, and we are here to help.

Cheers,

Marc

Source: Dalbar & Associates QAIB Study 2018; Capital Directions, LLC; M & A Consulting Group, LLC, doing business as CAM Investor Solutions is an SEC registered investment adviser. As a fee-only firm, we do not receive commissions nor sell any insurance products. We provide financial planning and investment information that we believe to be useful and accurate. However, there cannot be any guarantees. This blog has been provided solely for informational purposes and does not represent investment advice or provide an opinion regarding fairness of any transaction. It does not constitute an offer, solicitation or a recommendation to buy or sell any particular security or instrument or to adopt any investment strategy. Any stated performance does not reflect the expenses associated with the management of an actual portfolio. Past performance is not a guarantee of future results. Diversification does not eliminate the risk of market loss. Charts and graphs provided herein are for illustrative purposes only. There are many different interpretations of investment statistics and many different ideas about how to best use them. Nothing in this presentation should be interpreted to state or imply that past results are an indication of future performance. Tax planning and investment illustrations are provided for educational purposes and should not be considered tax advice or recommendations. Investors should seek additional advice from their financial advisor or tax professional.

Financial Planning Beats Market Volatility

In recent days the increase in volatility in the stock market has resulted in renewed anxiety for many investors. While it may be difficult to remain calm during a substantial market decline, it is important to remember that volatility is a normal part of investing. Additionally, for long-term investors, reacting emotionally to volatile markets may be more detrimental to portfolio performance than the drawdown itself. And don't forget, if you have established the proper financial planning strategy, most or any of this noise should have no impact on you.

Exhibit 1: US Market Intra-year Gains and Declines vs. Calendar Year Returns, 1979–2018

In US dollars. US Market is the Russell 3000 Index. Largest Intra-Year Gain refers to the largest market increase from trough to peak during the year. Largest Intra-Year Decline refers to the largest market decrease from peak to trough during the year. Frank Russell Company is the source and owner of the trademarks, service marks, and copyrights related to the Russell Indexes. Data is calculated off rounded daily returns.

 

Exhibit 1 shows calendar year returns for the US stock market since 1979, as well as the largest intra-year declines that occurred during a given year. During this period, the average intra-year decline was about 14%. About half of the years observed had declines of more than 10%, and around a third had declines of more than 15%. Despite substantial intra-year drops, calendar year returns were positive in 33 years out of the 40 examined. This goes to show just how common market declines are and how difficult it is to say whether a large intra-year decline will result in negative returns over the entire year.

REACTING AFFECTS PERFORMANCE

As we discussed in our recent blog, if one was to try to time the market in order to avoid the potential losses associated with periods of increased volatility, would this help or hinder long-term performance? If current market prices aggregate the information and expectations of market participants, stock mispricing cannot be systematically exploited through market timing. In other words, it is unlikely that investors can successfully time the market, and if they do manage it, it may be a result of luck rather than skill. Further complicating the prospect of market timing being additive to portfolio performance is the fact that a substantial proportion of the total return of stocks over long periods comes from just a handful of days. Since investors are unlikely to be able to identify in advance which days will have strong returns and which will not, the prudent course is likely to remain invested during periods of volatility rather than jump into and out of stocks. Otherwise, an investor runs the risk of being on the sidelines on days when returns happen to be strongly positive.

Exhibit 2: Performance of the S&P 500 Index, 1990–2018

In US dollars. For illustrative purposes. The missed best day(s) examples assume that the hypothetical portfolio fully divested its holdings at the end of the day before the missed best day(s), held cash for the missed best day(s), and reinvested the entire portfolio in the S&P 500 at the end of the missed best day(s). Annualized returns for the missed best day(s) were calculated by substituting actual returns for the missed best day(s) with zero. S&P data © 2019 S&P Dow Jones Indices LLC, a division of S&P Global. All rights reserved. “One-Month US T- Bills” is the IA SBBI US 30 Day TBill TR USD, provided by Ibbotson Associates via Morningstar Direct. Data is calculated off rounded daily index values.

 

Exhibit 2 helps illustrate this point. It shows the annualized compound return of the S&P 500 Index going back to 1990 and illustrates the impact of missing out on just a few days of strong returns. The bars represent the hypothetical growth of $1,000 over the period and show what happened if you missed the best single day during the period and what happened if you missed a handful of the best single days. The data shows that being on the sidelines for only a few of the best single days in the market would have resulted in substantially lower returns than the total period had to offer.

SO WHAT DOES THIS MEAN

While market volatility can be nerve-racking for investors, reacting emotionally and changing long-term investment strategies in response to short-term declines could prove more harmful than helpful. By adhering to a well-thoughtout financial plan, ideally agreed upon in advance of periods of volatility, investors may be better able to remain calm during periods of short-term uncertainty.

As always, we appreciate our relationship with you, and we are here to help.

Cheers,

Marc

Source: Frank Russell Company; Morningstar; Ibbotson & Associates; Dimensional Fund Advisors; Standard and Poors; M & A Consulting Group, LLC, doing business as CAM Investor Solutions is an SEC registered investment adviser. As a fee-only firm, we do not receive commissions nor sell any insurance products. We provide financial planning and investment information that we believe to be useful and accurate. However, there cannot be any guarantees. This blog has been provided solely for informational purposes and does not represent investment advice or provide an opinion regarding fairness of any transaction. It does not constitute an offer, solicitation or a recommendation to buy or sell any particular security or instrument or to adopt any investment strategy. Any stated performance does not reflect the expenses associated with the management of an actual portfolio. Past performance is not a guarantee of future results. Diversification does not eliminate the risk of market loss. Charts and graphs provided herein are for illustrative purposes only. There are many different interpretations of investment statistics and many different ideas about how to best use them. Nothing in this presentation should be interpreted to state or imply that past results are an indication of future performance. Tax planning and investment illustrations are provided for educational purposes and should not be considered tax advice or recommendations. Investors should seek additional advice from their financial advisor or tax professional.

Has a Global Recession Arrived

Some claim that a global recession has begun following a lot of the recent economic data. Others might argue that major problems only exist overseas, and signs of any recession is not present in the United States.

Regardless of who is right, we expect a recession won't be confirmed until twelve months or longer after the fact. This is similar to what we've seen in the past and is usually confirmed by the National Bureau of Economic Research (NBER) as well as other sources. The challenge is that predicting a recession is harder than you think.

INTEREST RATES

A lot of this debate and investor concern has been fueled by the recent steep decline in interest rates and does deserve further attention. Many of you may be wondering what happens if we experience zero or negative interest rates in the future? To be blunt, nobody knows with certainty what will happen because we've never experienced such an environment in the United States. It's also expected many "experts" will pretend they know what will happen and we recommend investors use caution around those who provide this kind of advice. Just remember, interest rates can increase too which many seem to forget.

As many of you know, our firm uses facts, logic, and an evidence-based approach to financial planning and investing. Instead of trying to forecast or "guess" future events, we look to focus on what we know to be true as well as seek to provide our clients with a higher probability of success. In our recent blog A Stock Market Cycle and Investor Discipline, we highlighted interest rate yields and inflation expectations are at generational lows. Given this current environment, we address several investor questions below that relate to the possibility of zero (or negative) interest rates including considerations for the next recession:

If we anticipate a recession is coming, should we get out of the stock market and go to cash and bonds? No. If you have a good financial plan in place that is properly managing investment risk and liquidity, then you should have been planning for market volatility (or you would have been 100% in the stock market). Also, some bond strategies may carry more risk than you think even though they are deemed to be safe.

Aren't my treasury bills (T-bills) safe in a recession or low-rate environment? Yes, the principal value for individual issues is guaranteed, however, T-bills are not immune to inflation. There are other solutions to accomplish this.

Should we continue to expect low inflation? By traditional measurements, inflation is at generational lows in the United States. However, if you look closer it is present in the economic data and in the goods and services we buy every day. Should tariffs continue, this is expected to also push up inflation pressures.

Should I sell all my fixed income if rates go to zero? Probably not all, but yes, it's possible some of the longer duration or higher risk bond funds may no longer offer appropriate compensation for risk. Fixed income has had a historic bull market given declining rates. At these levels it seems reasonable to expect most fixed income will produce lower returns going forward and some of these strategies may also bear greater risk if rates reverse course and increase. Hence, some holdings may warrant selling and rebalancing into higher quality, short-term duration funds which should still provide ample liquidity, but be less sensitive to interest rate fluctuations. In terms of individual bonds, their yield to maturity or yield to worst should not be impacted.

Given the risk of recession and interest rate fluctuations, will this hurt my real estate investments? Not necessarily as it depends on what sector of real estate (public vs. private; residential vs. commercial, etc.). Also, if short-term interest rates began to rise, it doesn't mean this will be bad for the sector.

Are there any fixed income strategies to consider that are not tied to interest rate fluctuations? Yes, some exist such as alternative lending, private debt, and inflation protection strategies. However, it is important to evaluate if these are appropriate in the context of one's risk tolerance and asset allocation.

Should I still hold as much cash if rates keep dropping? Any good financial plan will always retain a healthy amount of cash for emergency reserves, essential living expenses, and other needs. This level of liquidity avoids having to sell or realize losses in a down market or tough recessionary environment.

Given recession risks, should I reallocate into alternative investments? While some alternatives may offer diversification benefits for certain investors, many of these solutions will still feel the pain and impact of weak economic activity and recessionary periods. In particular, many private alternatives don't price each day or will experience a lag in reporting. Lack of liquidity is often an issue too for many private alternatives during a period of distress.

Should I own individual bonds or bond mutual funds? Potentially both, especially if rates continue to fall further.

How long should we expect low interest rates? There is a lot of research that suggests the best predictor of future rates are today's interest rates. So, it's possible low rates may continue for some time.

What is the impact of a long-term, low rate environment? Its positive for those looking to borrow, refinance, structure businesses, debt, and many other common financial needs. For income investors, it may present a challenge to generate enough income due to lower yields. It also seems reasonable to expect that traditional fixed income returns will be lower in the future compared to the past twenty or thirty years. This will impact financial planning and retirement income expectations for some. A low-rate world may also decrease future stock market returns which was a critical discussion that we covered earlier this year in The 60/40 Investment Debate.

For investors who have a sound financial plan in place and are properly managing risk, most of this discussion should have no impact on you. However, a second opinion never hurts.

As always, we appreciate our relationship with you, and we are here to help.

Best,
Marc

Source:  J.P. Morgan; Federal Reserve Bank of St. Louis; Dimensional Fund Advisors; Bloomberg; Stone Ridge Asset Management. M & A Consulting Group, LLC, doing business as CAM Investor Solutions is an SEC registered investment adviser. As a fee-only firm, we do not receive commissions nor sell any insurance products. We provide financial planning and investment information that we believe to be useful and accurate. However, there cannot be any guarantees. This blog has been provided solely for informational purposes and does not represent investment advice or provide an opinion regarding fairness of any transaction. It does not constitute an offer, solicitation or a recommendation to buy or sell any particular security or instrument or to adopt any investment strategy. Any stated performance does not reflect the expenses associated with the management of an actual portfolio. Past performance is not a guarantee of future results. Diversification does not eliminate the risk of market loss. Charts and graphs provided herein are for illustrative purposes only. There are many different interpretations of investment statistics and many different ideas about how to best use them. Nothing in this presentation should be interpreted to state or imply that past results are an indication of future performance. Tax planning and investment illustrations are provided for educational purposes and should not be considered tax advice or recommendations. Investors should seek additional advice from their financial advisor or tax professional.