Are we really looking at the same stock market we bemoaned only a month ago? In December, China trade negotiations and the Federal Reserve’s next move were core concerns. Investors were pricing in a recession in 2019 or early 2020 with a 16% drop in MSCI All-Country World Stock Index in Q4.
One month later, sentiment has shifted. The same global index of stocks is up 7.9%, including dividends. Many of the same prognosticators that predicted an imminent recession now believe it’s unlikely. The Federal Reserve signaled a pause in rate hikes, China moved to stimulate their economy, and a glimmer of optimism surfaced about a trade deal. Still, stock market volatility is likely to be the norm rather than the exception this year.
The sentiment rebound also supported corporate bonds. High yield and investment grade bonds gained on the backs of higher stock prices. With the Fed thought to be on hold and inflation subdued, investors are feeling better about taking risk in the bond market.
The sharp selloff and recovery are reminders that long-term investing success often depends on our reactions (or lack thereof) to the market’s ups and downs. Intellectually, we know that volatility is a given and that shifts in sentiment are normal, but fight-or-flight emotions kick in during wild market swings. It’s in our DNA and difficult to override.
The Right Road
James Lui at Clearnomics writes:
In many ways, investing for long-term goals is like planning a cross-country road trip. First, it's important to know where you want to go, to plan your route properly, and to tune up your car beforehand. Second, what matters more than anything else is that you take the right interstates and drive in the right direction. You may be able to save some time with clever navigation or by weaving in and out of traffic. But these benefits are secondary to staying on the right road, especially if they cause you to miss an exit.
Finally, it's important to expect detours, road construction, bad weather, and other complications. While these may slow you down, they won't stop you from reaching your destination.
At the end of the day it takes discipline and no small amount of intestinal fortitude to apply the same principles to your portfolio. The key is to start with the correct perspective. You can choose to view the investment landscape as either an investor or a speculator. As an investor, you see that true investing is a process that occurs over time periods of at least 5 years, and often over 10 or 20 years. One’s opinions about the markets and how they work are shaped by this long-term viewpoint. As an investor, you make decisions that reflect your needs over these longer periods, not on what will happen next month, next quarter, or even next year.
We wrote last month that for stocks to go lower, the economy would need to enter a recession. We still believe that to be true. Many analysts put a finer point on that, deploying some heftier mathematics.
These models distill economic and financial market variables into one number measuring the risk of recession. One model, based primarily on the yield curve, published by the New York Federal Reserve puts the probability of recession in the next 12 months at 22%. Six months ago, the metric stood at 10%. The implication here is risks are elevated now compared to mid-2018.
What gets lost in this analysis is the fact that there is always some chance the economy hits a bump tomorrow. Based on history, that chance is about 20%. If someone returned from a long vacation on Mars without current knowledge of the markets or state of the economy, he or she would guess the chance of recession would be 20% in the next twelve months just by counting the number of years that have resulted in recession.
In our minds, 22% isn’t much different than 20%.
In investing, no one has all the information and even fewer have perfect foresight. It may feel today as though risks are elevated and you should do something about it. But now is not so unusual.
The good news is that prediction is not required to achieve great investing outcomes. Over time, having a good plan and staying on course is more important than trying to predict the market’s next moves.
Our advice is to resist the urge to overreact to short-term volatility and focus on taking the risks you need to reach long term goals.
What It All Means
Being comfortable with a longer investment horizon often means sitting tight when others are in a panic mode or giving the capital markets a chance to work for you, rather than trading at the first opportunity to realize gains or panicking during a downturn. The idea that “doing less with your portfolio is better” is often counterintuitive and difficult to accept. Investors sometimes ignore this truth in order to pursue something less important but more exciting. The problem is that excitement can be expensive, while more productive and profitable investment strategies can seem plodding and boring by comparison.
Investing is a journey. Having a good plan and keeping the financial markets and economic environment in perspective and staying disciplined are the best ways to reach your financial destination.
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DISCLOSURES: The information provided in this letter is for general informational purposes only and should not be considered an individualized recommendation of any particular security, strategy or investment product, and should not be construed as investment, legal or tax advice. Proffitt & Goodson, Inc. makes no warranties with regard to the information or results obtained by third parties and its use and disclaim any liability arising out of, or reliance on the information. The information is subject to change and, although based on information that Proffitt & Goodson, Inc. considers reliable, it is not guaranteed as to accuracy or completeness. Source information is obtained from independent financial data suppliers (Interactive Data Corporation, Morningstar, etc.). The Market Categories illustrated in this Financial Market Summary are indexes of specific equity, fixed income or other categories. An index reflects the underlying securities in a particular selection of securities picked due to a particular type of investment. These indexes account for the reinvestment of dividends and other income, but do not account for any transaction, custody, tax, or management fees encountered in real life. To that extent, these index numbers are artificial and cannot be duplicated in real life due to the necessity of paying those transaction, custody, tax, and management fees. Industry and specific sector returns (technology, utilities, etc.) do not account for the reinvestment of dividends or other income. Future events will cause these historical rates of return to be different in the future with the potential for loss as well as profit. Specific indexes may change their definition of particular security types included over time. These indexes reflect investments for a limited period of time and do not reflect performance in different economic or market cycles and are not intended to reflect the actual outcomes of any client of Proffitt & Goodson, Inc. Past performance does not guarantee future results.