“In investing, what is comfortable is rarely profitable.” – Robert Arnott, founder of Research Affiliates
Happy New Year! What a difference a year makes…or does it?
When I sat down to write our year-end commentary in 2018, the S&P 500 had its worst annual return since the 2008 financial crisis and the last four months of the year saw a 20% correction. The final quarter of 2018 was loaded with naysayers and the media was publishing negative headline after negative headline. My personal favorite came from MarketWatch – “The stock market just booked its ugliest Christmas Eve plunge – ever.”
Rightfully so, we heard from many of you who were impacted by the fear mongering and questioning if you should go to cash or position your portfolio more conservatively. I am happy to report that none of our clients went to cash during last years correction and, as a result, enjoyed one of the best performing years in market history. In 2019, the S&P 500 recorded its second-best post financial crisis era return barely missing the high mark set in 2013.
This time last year I shared one of my favorite formulas: E+R=O (Event + Response = Outcome) and encouraged each of you to control your response. Events are going to happen, and markets will rise and fall, but we can control our responses to those situations, which ultimately drives our outcome. This advice is no different today.
The Gambler's Fallacy
I want to build further on this formula and discuss a phenomenon known as the Gambler’s Fallacy. The most famous example of this happened in Las Vegas in 1913 at the roulette table. The ball had fallen on black several times in a row. This ultimately led people to believe that it would soon fall on red and they started doubling down. It took 27 times before the ball eventually fell on the red square and in the process millions of dollars were lost.
Thankfully the markets aren’t subject to a 50/50 chance – in fact, historical data shows that the S&P 500 is up 74% of the time. We all instinctively know that a coin flip or roulette spin has a 50% chance of landing on heads/tails or black/red so why do we adjust our responses based on prior results? Furthermore, why does this same mindset affect investment decisions when the markets are in your favor? To my knowledge no one predicted exactly what would happen in 2019 and I would argue that many of the so-called experts, pundits, and talking heads predicted the direct opposite to occur. So why do we listen to them?
I opened with the question on whether 2019 was really different than 2018 because the question we are hearing from clients sound exactly the same “should we be selling into cash or getting more conservative?” How can two directly opposing years in terms of performance yield the same question? Could it be the Gambler’s Fallacy indirectly driving our responses? In late 2018, clients felt it was the start of the fall and they wanted out before it fell further. Today, clients want out because they feel it can’t keep going higher – does this sound familiar to betting on red after previously landing on black?
What's in Store for 2020?
So, where do the markets go from here? The truth is in the short-term, I have no idea, but this does not change my long-term prospective and current response going forward. In fact, it reaffirms why we do what we do. We will continue to evaluate each of our clients’ investment allocations ensuring you have the right mix of equities and fixed income to weather an impending storm when it eventually arrives (whether tomorrow, next year, or 10 years from now).
We will also continue to proactively tax-loss harvest and heed our dynamic rebalancing approach, allowing the markets to dictate what we do, when we do it, regardless if they are up or down. So while it may be comfortable to sit on the sidelines I am going to share the same advice that I share with my clients – stay the course and allow your financial plan to dictate your investment decisions and remember that “what is comfortable is rarely profitable”. Take comfort knowing that future corrections have already been priced into your plan and enjoy these good times!
What Does History Say?
I will leave you with some fascinating research from Nick Maggiulli, writer of Of Dollars and Data. He analyzed each prior 20-year return period and the ensuing 10-year future growth of the S&P 500. From January 2000 to December 2019, the S&P 500 compounded at a rate of about 6.3%. Historically, markets compounding in the 6% to 6.5% range over the prior 20 years went on to have above average growth over the next 10 years. Neither Nick nor I are claiming this will happen, but I would rather put my money on history than to implement the Gambler’s Fallacy and assume 2020 will be a down because 2019 was up.
Have a great 2020! Stay disciplined, remain uncomfortable, and enjoy your future success. If you have any questions or want to further discuss the markets or your financial plan, please don’t hesitate to contact us.
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