Keeping Your Emotions In Check

Jason Hochstadt |

REMINDER: Past performance is not a predictor of future returns. Nothing contained herein shall be construed as the rendering of personalized investment advice or providing our opinion as to the merits of a particular investment or strategy. We also have no idea as to future performance for any asset class over any future time period; if we did, investing would be a lot easier!

If one were to wait until the coast is clear before investing, he or she would never commit capital to any investment. Risk, however you choose to define it, is omnipresent. We often write about various individual stocks suffering major declines to reinforce (a) why diversification among stocks (and asset classes) is critical and (b) even when the stock market is doing well, there are plenty of stocks which have depreciated considerably in value. We know first-hand it is not easy to be an investor and experience losses. Unfortunately, it is impossible to avoid losses all of the time if one wants to grow his or her capital. As noted by investor Barry Ritholtz recently in an article titled, “Why You Should Stick With ‘Buy and Hold,’ “If you cannot live through a 25% pullback in the value of your portfolio, you have no business owning stocks.” Particularly when losses come fast and furious, as they have recently, we tend to think the sky is falling and there is no light at the end of the tunnel. As famed investor Benjamin Graham surmised, “The investor’s chief problem – and even his worst enemy – is likely himself.”

For every argument in favor of a particular investment or asset class, there is seemingly an equally plausible counter argument, if not many. As an example, this past week’s stock market drop, with the major averages/indices falling between (4.5%) and (5.0%) (representing the worst start to December since 2008), actually followed the S&P 500’s best week in seven years. November was a positive performance among the major stock market indices after a horrific October. Also, the yield curve has experienced a considerable narrowing in its slope, to the point where there was an inversion of the 3 versus 5-year U.S. Treasury last week (meaning the yield on 3-year Treasuries exceeded that of 5-years). As noted in the 12/10/18 issue of Barrons, in 6 of 7 instances when this occurred the (a) median distance to a recession was 25 months (so over 2 years) and (b) the S&P 500 Index went on to earn a median 20% over the following 24 months. At least with stocks we know we have partial ownership of an entity and its assets, cash flows, operations, etc. Pity the investor who jumped aboard the cryptocurrency train for fear of missing out, only to endure bitcoin’s whopping (80%) decline in value (86% from its January, 2018 peak), including a (37%) fall in December alone!

As you know, we have no idea what the stock market’s performance will be tomorrow, next week, the following month, year or years. Neither does anyone else for that matter. We do know that the longer one’s investment time horizon, the more likely they will achieve positive returns by investing in the stock market. And with ever increasing life expectancies resulting in longer retirements to fund, combined with the effects of inflation and financial inadequacy of countless government programs as presently constructed, it is important to include and remain committed to stocks as part of one’s portfolio. Yet, stocks do not go up in a straight line. As noted by value investor Chris Davis, on average we should expect a 5% correction every 51 trading days and a 20% correction (or bear market) every 630 trading days. Currently, We’ve gone over 2,400 days without a (20%) decline – although we’ve had two (10%) declines from peak to trough in 2018. According to Jeremy Siegel, Wharton Professor, the average daily change in the stock market over the past 100 years is 2/3 of 1%. As contained in the attached page courtesy of State Street Global Advisors from mid-November, 2018, (a) the S&P 500 Index fell about (10%) in October (with mid and small-cap indices fairing even worse), (b) the average market correction during mid-term Presidential election years is actually considerably worse [an (18%)] fall and (c) historically, the S&P 500 Index was up an average of 31% the subsequent 12 months after such a correction – never having finished in the red during this time (encompassing 14 different occasions since 1962). Sam Stovall, Chief Investment Strategist at CFRA, noted that from 1946 – 2014, the S&P 500 Index average price return 12 months after the mid-term election (from 10/31 thru 10/31 of the subsequent year) averaged 14.5% - with positive returns in all 18 years. We are certainly not stating this will come to fruition over the coming year (particularly in light of the Federal Reserve’s quantitative tightening as compared with its easy monetary policy from 2008 – 2016); however, it is useful to put market declines into proper historical context. Especially considering that, since 1900, the median bull market has lasted roughly two times as long as the median bear market (35 months versus 18 months), and with a more than 2:1 upside/downside ratio (+53% for the median bull market versus -25% for the median bear market).

Recently, there has been nowhere to run and nowhere to hide, so to speak, with respect to the investing environment. For example:

  • 12/07/18 WSJ article titled, “Bear Markets Across the Globe.

    • Germany’s major stock market index (the DAX) was recently down over 20% from its peak – representative of a bear market.

    • Other countries experiencing bear markets with respect to their stock markets include the likes of Italy, China, Hong Kong and South Korea. Emerging market indices overall have been in a bear market (suffering from a combination of trade/tariff tensions; a stronger U.S. dollar; higher U.S. interest rates; etc.) as has the price of oil.

  • 12/05/18 article entitled, “It’s the Worst Time to Make Money in Markets Since 1972.

  • 12/05/18 InvestmentNews article titled, “Bonds are pulling portfolios into negative territory…

    • Thru the first week of December, the (a) Bloomberg Barclays Aggregate Bond Index (a proxy for the investment-grade bond market) was down (1.3%) for the year-to-date, with (b) corporate bonds down (3.0%) overall. Similarly, the Bloomberg Barclays Global Aggregate Index of government and corporate bonds was down (3.2%) for the year-to-date.

  • Even one of America’s richest suburbs, New York’s Westchester County, lost its AAG grade from S&P Global Ratings and Fitch Ratings last month after drawing down its cash reserves and experiencing structural budgetary issues that, in the words of the county’s new executive, “is serious financial stress.” Accordingly, credit deterioration can result in lower prices for municipal bonds such as theirs.

  • In the U.S., the “FAANG” stocks, and information technology in general, which had propelled much of the stock market gains, has reversed itself. From previous highs this year, each “FAANG” stock is now in its own bear market – with the cumulative losses exceeding $1 trillion from highs earlier this year.

    • Facebook was down over (41%) in a few month span – and is actually down over (22%) for the year-to-date thru 12/0718.

    • Apple was down (20%) in a month-and-a half (10/03/18 – 11/14/18).

    • Amazon was down (25%) in under two months (09/04/18 – 10/30/18).

    • Netflix was down roughly 1/3 (33.3%) from 07/09/18 – 11/16/18.

    • Google (Alphabet) was likewise down (20%) from 07/26/18 – 10/29/18.

Much of the stock market’s moves are based upon expectations and whether or not actual results exceed or lag such expectations. Unfortunately, no one has a crystal ball to accurately predict the future. Additionally, a great company is not necessarily a great stock; a strong economy does not necessarily mean there will be a strong stock market; and so forth. We did find of interest commentary from a few managers we follow (all aside from Chris Davis manage mutual funds we currently utilize) from November or December – so their commentary takes into account October’s correction.

  • Chris Davis, Chairman and Portfolio Manager of Davis Funds (focused principally on large-cap global value stocks): He believes you make most of your money in a bear market. Even now, with all the turbulence being experienced he stated last month that, “We love bad headlines. We love the prices that they create. The volatility is tough, but this is a great time when looking to select developing markets, and within those markets, the companies that have really dominant growth franchises – that are not sensitive to these trade disputes and so on. When you can buy those at cheap multiples, it’s a value investor’s dream. We really do see this unfolding now in select developing markets.”

  • Chuck Royce, Chairman of Royce Funds, and Francis Gannon, Co-Chief Investor Officer of Royce Funds (focused principally on domestic small-cap value stocks): While acknowledging “there is plenty of risk in the equation” with respect to the current stock market, they stated that, “We added to the stocks we like, and we like a variety of types of stocks. We always, as a firm, want to add in declines. The earnings news we’ve been hearing from companies and the preliminary data that we’ve examined both show ongoing – and in some cases, growing – small-cap earnings strength for key cyclical sectors including Industrials, Materials, Energy and Financials.”

  • Centerstone Investors (invests across all-cap value stocks throughout the world): According to Managing Partner Ashwin Paranandi, with portfolio manager Abhay Deshpande having recently returned from a trip to Europe, “only a handful of companies expressed any concerns regarding a slowdown in Europe, China, the U.S., or even about tariffs.” As an example, between March and June of this year a leading Indonesian cement manufacturer saw its stock drop 45%. As per Abhay Deshpande, Centerstone’s portfolio manager, “Virtually nothing had changed; this business is doing fine. A competitor is being auctioned in Indonesia and the prices being discussed would indicate this company is very cheap.

  • Michael Fredericks, Head of Income Investing for BlackRock’s Multi-Asset Strategies Team and lead portfolio manager for the BlackRock Multi-Asset Income Fund (a balanced fund that primarily owns debt securities - with large-cap blend stocks on the stock side): Although conservatively positioned, the Fund added somewhat to its U.S. equity exposure in spite of risk factors since, “we believe this sell-off has restored some value in the markets and creates an attractive entry point for U.S. equities, particularly given our view that the domestic economy remains healthy heading into 2019.”

  • Matthew McLennan, co-lead portfolio manager of First Eagle Global (a global balanced fund that owns domestic and foreign stocks of all caps - albeit principally large and mid-caps): As contained in the 12/05/18 interview with Barron’s titled, A Top Money Manager Sees Really Nearing Its End,” Mr. McLennan is not too optimistic about the coming year for a host of reasons – being late cycle; the level of global debt; concern over reduction in future profit margins; a slowing world economy; etc. Mr. McLennan did reference owning companies that have an ‘element of resilience’ and, “As prices came down and there was a lot of damage beneath the surface of the market, we were able to put some money to work.

    • As of 10/31/18, the Fund’s equity allocation was 71.6% (about evenly split between the U.S. and foreign markets). Note that, since 2003, its lowest equity allocation was 58.2% in early 2005. Cash was recently at 15.0% of Fund assets; it was over 20% at the beginning of 2017 and its all-time high was 29.1% also in early 2005. Gold, used as a potential hedge, was over 12% of assets (both bullion and gold mining stocks) – which is toward the high range over the past 15 years.

When the stock market declines by a large %, particularly over a short period of time, it is useful to remind yourself of a few things:

  1. This is why you should not (and do not) have all your money invested in stocks (and remember this the next time the markets are in an upward trajectory).

  1. This is also why you should be diversified among various types of stocks – as they don’t always act in unison (e.g. the utilities sector was the lone sector in the black last week, with a 1.3% return, despite every other sector having finished in the red between (3.2%) and (5.9%), respectively).

  1. Review your investments in the context of your overall finances and balance sheet – as you may have other assets and/or cash flows not tied to the stock market (e.g. Social Security benefits; cash value life insurance; etc.).

  1. Don’t check your account values daily. Imagine how you’d feel if your house was valued on a daily basis!

  1. Try your best to tune out the extra noise from all the pundits, media and others who claim to know what will be happening and what you should do on a daily basis.

    • Lastly, check out the attached article courtesy of J.P. Morgan Asset Management from 11/23/18 entitled, “Navigating Volatile Markets: Get Invested, Stay Invested.” Although we’ve reviewed the topics discussed in the past, it’s always useful to have a refresher with data presented in a somewhat different manner. For example, as pointed out in Exhibit 4, the best performing day for the S&P 500 Index in 2015 (August 26th) occurred merely two days after the worst (August 24th). You think anyone knew this in advance?

As always, please do not hesitate to contact us if you’d care to review anything contained herein or otherwise. We wish you and your family a joyous Holiday season, terrific end to 2018 and (gulp) Happy 2019!



To ensure compliance with requirements imposed bythe IRS, we inform you that any U.S. tax advice contained in this communication (including any attachments)is not intended or written to be used, and cannot be used for the purpose of (i) avoiding penalties under the InternalRevenue Code or (ii) promoting, marketing or recommendingto another party any transaction or matter addressed herein.