“Ultimately, success in investing is not measured by how much you gain in a bull market but how much you avoid losing when the tide turns.”
- Steve Blumenthal
As Summer turned to Fall last year, we decided to dust off the old keyboard (I wanted to say type writer but haven’t seen one of those around here in quite some time) to begin commenting on markets. It had been a while since we had written much about markets. As a side note: The hiatus was nice and gave us time to work on our Lunch and Learns which have become so well attended that we are now doing them twice a month with conversations of adding a third. Thanks to all of you that have attended as well as the Quiver staff that makes the events happen.
So why start writing about markets now or then? Throughout 2015 there were some subtle changes taking place, things you wouldn’t notice on the surface. However, they were the type of changes that if you have been around markets long enough you have learned they were worth paying attention to. These shifts in markets is what prompted us to do our
Fall event entitled ‘Making Chaos and Crisis Your Friend’ where we posed the question, “Will August mark the end of the Bull Market?”. Considering the market action since then, our timing in asking the question was prescient.
Fast forwarding to present time, January is typically a pretty decent month in markets as there are some structural cycles that tend to help support markets towards the end of December and beginning of January. Apparently, no one gave the 2016 markets the memo. January 2016 went into the history books as one of the worse performing months for stocks and commodities, catching many by surprise. Since I am not a big fan of surprises my goal today is twofold. One, to reiterate some of the things we have been expressing in our recent Lunch and Learns and two, help you find opportunities within a market that may be more challenging than you may like.
Let’s start with some factoids that are important to keep in mind and that help us center the way we do things here at Quiver. It’s a little known but startling fact: The average buy-and-hold stock market investor spends 74% of his or her time recovering from cyclical downturns in the market (from 1900 to May 2015), according to Ned Davis Research.
This is sensible considering very few people have a discipline to sell or take profits when times are good. However, it’s important to remember that the power of compounding helps on the way up and hurts on the way down. For example, a loss of 20% requires a 25% recovery to get back to even. It is the 40% to 50% declines that keep you from reaching goals. Overcoming a 50% decline takes a subsequent 100% gain. Avoiding large losses across an entire portfolio is paramount if your time frame is less than 15 years, especially if you are requiring income during those years. For this reason we believe the best advisor or manager is a risk manager.
Such drastic declines tend to happen in recessions so it is that which we must defend our portfolios against.
It is our view, which has been expressed for quite some time that from a technical perspective the declines in markets in August 2015 was the first shock, the declines in January the second shock and the probabilities we are in a cyclical bear market with additional shocks ahead is quite high.
Many of you reading this may not be able to act quickly enough to avoid the next shock (if there is one) so it will become important to then strategize on how to create the best path to recovery as well as prevention from additional market shocks if they should occur.
Ironically, there is much less risk investing in equities after corrections. This is why we believe in a diversification process that determines how much money to allocate to equities, fixed income and alternatives based on your risk appetite and market cycles. If your equity portion is properly hedged and a large market decline happens, the opportunity to remove hedges and place those funds into equities when the forward returns are higher may be a good strategy in managing risk and increasing recovery rates.
Proper diversification should also have an emphasis on keeping correlation between the holdings to a minimum. The problem with traditional diversification that most investors have been taught is that it lacks a focus on correlation. Who needs 10 mutual funds with different names if they all go up and down in tandem with the market?
Ultimately, it is about developing a game plan and sticking to a process. Have a plan that acknowledges the realities of our financial system – bear markets and recessions happen. They are built into the system. What goes up will go down. This market has been going up for a decent stretch of time. When it drops, it can be precipitous and very few will be spared from seeing declines in their accounts. As in most things in life what will matter is what you do next.
For each of you the next steps could be different based on many different factors. In an effort to close out this missive with some actionable items to help you see the opportunities when they arise I offer the following:
First: I can’t emphasize enough the importance of a portfolio stress test. This is a process of testing a portfolio against different stresses to see where the vulnerabilities exist. When doing a stress test after a decline it should then also focus on creating the best possible rate of recovery.
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Second: If you have cash that has been on the side lines, don’t let the market volatility prevent you from putting the funds to work. As mentioned before, risks tend to be less after a decline.
The phrase, “buy when everyone else is selling” makes logical sense but can be harder to act on when your emotions get involved. This is why having a plan centered on some disciplines is important.
Third: If you’re not sure of anything come see us or come see one of our future Lunch and Learns.
Time to run, its Job’s Friday, the day the monthly employment numbers come out. Other than Fed day, there isn’t another day that carries as much noise which is always entertaining to watch.
The opinions expressed are those of Colby McFadden and Quiver Financial as of February 5, 2016 and are subject to change due to market or other conditions. This is not a solicitation or recommendation of any investment; always consult a Financial Advisor before investing into any investment. Securities offered through Newport Coast Securities, Inc. - Member FINRA / SIPC - Advisory Services Offered through Newport Coast Securities, Inc. 18872 MacArthur, 1st Floor, Irvine, CA 92612 - 800.992.5592