The GFC (Global Financial Crisis) is widely considered by economists to have been the worst financial crisis since the Great Depression. Its effects were so wide-spread and profound that even Queen Elizabeth, whose personal fortune had fallen by more than $50 million, demanded economists explain why they hadn’t seen the crisis coming.
Around the world blame was distributed far and wide – lax regulations, too much regulation, excessive debt, irresponsible lending, complex financial products, compromised ratings agencies, an over-reliance on mathematical models, and just plain old greed were all cited as culprits.
But aside from a temporary seizure in short-term money markets, global share and bond markets performed as you would expect at a time of heightened uncertainty. Prices adjusted lower as investors demanded a higher expected return for the risk of investing.
And it wasn’t long before the markets started to see a reversal – By the end of 2009, the New Zealand market rebounded by more than 19% after a near 34% decline in 2008. Australia’s S&P/ASX 300 index performed even better, returning to almost the same levels as before the GFC.
Emotions are hard to keep in check during a crisis and there can be an overwhelming compulsion among investors to “do something”. But, as it turned out, those who listened to their advisors and stayed disciplined within the asset allocation designed for them have done considerably better than many people who capitulated and went to cash in 2008−2009.
An investor who had begun investing in the New Zealand market at the start of 2008 would still have experienced a 7.6% annualised return by the end of 2017. Using a global balanced strategy of 60% equity and 40% fixed interest, the return was 5.4%p.a.These results show we can do ourselves a favour, both materially and emotionally, by accepting that volatility is a normal part of investing and by sticking to a well-thought-out investment plan agreed upon in less stressful times.
This blog has been taken from an article by Jim Parker of Dimensional. Read the full story here
Putting the recent market volatility into a longer term context
In the first three weeks of January 2018 alone the S&P 500 crossed ten new record closing highs in 13 days of trading. Then, in February, the index lost all its gains from 2018 in a few days. Over the next 7 months it built up gains again, and then lost all them over the course of three weeks in October. What’s going on?
Let’s remind ourselves how markets work.
Prices went down because some investors decided to sell. But for every seller there is a willing buyer. The aim of the buyer wasn’t to lose money. The buyer bought because they felt that the discounted prices offered them enough return to justify the risk.
Markets bring optimists and pessimists together by finding a price at which they are both willing to trade.
This is our shorthand way of saying at least half the market participants transacting in the last few days thought it was a good time to buy. Not everyone believes the sky is falling, even if the sensational headlines promote such a view.
But what about our investors?
For our clients with a 50/50 portfolio, we recommend a seven-year time horizon at a minimum, and most have a 20 or 30 year time horizon. In other words, any of our investors that are planning to spend money out of their portfolio this year or next year probably have that money sitting in bonds and cash, not in shares.
So, the portion of the portfolio suffering the most from this recent volatility is the portion that an investor has almost no chance of spending or using any time soon. That’s important, because it means that, whilst it’s not particularly comfortable to see volatility like this, it has little practical implication on their portfolio or current lifestyle. For most of our clients, we hope they’d look on this current situation with a level of disinterest.
For clients that are regularly purchasing assets in their portfolios or via KiwiSaver, this is fact a positive development, because they’ll be able to buy more shares with their same regular savings contribution and that will help grow their long-term wealth.
And let’s remember, when we as investors agreed to purchase shares, we accepted this would generally lead to more volatile returns. However, it’s volatility such as this that gives shares their wonderful return characteristics. Without temporary dips such as this most recent one, shares would have the returns of cash – which would not help us reach our financial goals.
Shares are volatile. The chart below shows the quarterly return of a portfolio 98% invested in shares. It goes up and down a lot; there’s no way around it. The chart below, however, shows the growth of wealth this same portfolio has produced since 1991. While the volatility was uncomfortable, it produced large growth despite the Asian financial crisis, the tech wreck, the Global Financial Crisis and anything else you want to throw into the last 20 years or so.
The critical point to remember in all this is the outcome that long term investors get to experience. It’s that share markets, on average, go up more than they go down, and that consistent exposure to these markets is a key driver of long-term wealth creation.
We know the markets can be volatile in the short term, but this is already factored in to our long-term strategies. The worst decision investors can make is to react to short term volatility in a way that jeopardises the achievement of their long-term plans.
If you are still concerned, we want to talk. Give your adviser a call and we’ll be happy to talk through the recent changes to your portfolio in the context of both your short and longer term goals.
Our thanks to Ben Brinkerhoff from our associate company, Consilium, for this great article.
How about that 550-point intraday dive last week in the Dow! Did that finally get you to sell?
Or was it one of the many headlines about the trillions of dollars that have been wiped out of the stock market in the worst start for the Dow in history — since 1897! And worst start for the S&P 500 since the Great Depression began in 1929.
Oh, c’mon, that was “so last Wednesday.”
Surely, when all the major indices ripped higher on Friday, and stocks registered their first positive week of the year, and that diving-Dow had two straight days with triple-digit gains, you had plowed right back into the stock market and banked all those big gains.
It seemed like the panic and the paranoia were over — until the Dow dropped by another 200 points on Monday.
And so far in January, investors have yanked near-$7 billion from U.S. stock funds, according to Thomson Reuters Lipper data. Investors have also put more than $3 billion into money market funds — the market’s under-the-mattress cash equivalent. But the more alarming data comes from last month, when investors pulled $48 billion from stock funds. That is eerily similar to 2008, as the financial crash hardened: Investors took $49 billion out of stock funds in Sept. 2008 and $55 billion out of stock funds in October 2008.
Kudos to investors for the great timing. Except for the fact that from 2008 to 2012, the S&P 500 generated a cumulative return of 8.6 percent.
Here’s the problem: If an investor missed the 36 percent drop in the S&P 500 in 2008 — or even worse, bailed on the markets mid-carnage — they probably also missed the 26 percent gain in the S&P 500 in 2009, and the next three positive years for the index that followed.
In 2011, investors pulled another $94 billion from stock funds, and in 2012 another $129 billion, when the S&P 500 was up 16 percent. Hundreds of billions of dollars pulled out of stocks during a period of time when a stay-the-course strategy would have netted an 8.6 percent cumulative gain. Not a shoot-the-lights-out strategy, but nothing to sneeze at either in today’s low-return — not to mention nil savings rate — environment.
“The global financial crisis created such a high level of risk aversion that people didn’t just wait for the start of the rebound. In some cases, they waited for years,” said Kristina Hooper, U.S. investment strategist at Allianz Global Investors. “I can’t tell you how many investors I came across in 2011, 2012 and even 2013 who had missed out on a lot of the comeback in the stock market and were still sitting in cash.”
It’s what Lipper’s head of Americas Research, Jeff Tjornehoj, calls the dilemma of the do-nothing investor: More often than not, the do-nothing investor does better.
“It’s a rocky ride, but the do-nothing investor would have been fine and avoided headaches,” Tjornehoj said, referring to those who stayed invested through the crash. He added, “If you know precisely how to move between stocks and bonds and everything else, you would have done better, but how many investors know how to do that?”
“The big issue is that when you go to cash, you have to be right twice,” said Mitch Goldberg, financial advisor and president of Dix Hills, New York-based ClientFirst Strategy. “First, you have to be right about getting your timing correct when you sell. If you are selling because it is your panic reaction in a down market, I think it’s fair to say you probably got that part of the decision wrong. The second part you have to get right is the timing of your buy orders. And if you are waiting for the perfect time to buy, you’ll never pull the trigger.”
And here’s a key that many investors who plan to be smarter than the “herd” miss, especially in markets like the one investors faced last week, with huge swings in the norm day-to-day. A move to cash works against the investor to a greater degree when there is greater volatility.
“Friday’s rally in global equity markets is a case in point of how investors who just binged on cash are missing out on a big rebound,” Goldberg said. “It’s tough to time, and missing out on the best days of the year has a restraining effect on long-term performance,” Goldberg said.
Allianz Global Investors provided an example of just how much investors can lose out in just a few days. The Allianz economic research and strategy team looked at the period from 1973 to the end of 2014, comparing four different approaches to investing in the U.S. stock market. Investors who missed the three biggest days of each year see their gains go down dramatically.
In the first approach, $100 is invested on the first day of the year and another $100 dollars added at the start of each year thereafter. The total return over the four decades was $52,251.
In the market-timing approach, if an investor invests the same $100 at the start of each year but misses the top three days of the year, the total return was $2,953.
The best return of all came from investing $100 on the day of the lowest index level of the year — the best day of the year to invest — and adding $100 on the lowest-index-level days of subsequent years. That approach netted a total return of $54,355.
“The problem is that we can never predict when the best days will occur, so we have to stay fully invested all the time to experience them,” Hooper said, adding that most days in any given year (both positive and negative) will typically produce a net flat performance.
Those “big day” misses, or gains, compound over the years.
The key problem I see when investors go to cash has a lot to do with procrastination,” Goldberg said. “They think about getting back into the market in a conceptual way, but when it comes right down to it, they often don’t because they didn’t implement a disciplined strategy to get back in. If the stock market bounces and rips higher, they say to themselves, ‘I could’ve gotten in lower, so now I’ll wait for another pullback.’ Then the market pulls back and they say to themselves, ‘I’ll wait to see if it goes lower.’ And so on.”
Tim Maurer, director of personal finance for The BAM Alliance of financial advisory companies, said that the field of behavioral finance has demonstrated how our brains often think (wrongly) when it comes to evaluating the pain of losses versus the pleasure of gains.
Maurer said to consider the decision between staying invested after a market decline or moving to cash as a four-step process:
The pain of staying invested is that I could lose even more.
The pleasure of moving to cash is that my worry is eliminated and I’m guaranteed not to lose any more.
The pain involved in moving to cash is that I’ll miss the upside, thereby eliminating my opportunity to recoup recent losses in the next market up move.
The pleasure in staying invested is that I’m giving myself a better chance to achieve my financial goals in the long term — the reason I invested in the market in the first place.
He said the four-step process has one purpose: to bring the vast majority of investors back to the conclusion that they shouldn’t get out of the market.
“The market has historically paid investors a premium over cash and bonds precisely because it requires investors to endure times of volatility,” Maurer said. “Without volatility, we’d have no reason to expect higher long-term gains.”
A few weeks ago — amid one of the many recent bouts of extreme daily selling — a friend asked me whether they should sell their Facebook shares. I asked, “And replace them with what?” She didn’t have an answer.
Another friend, in his 40s, texted in a panic to ask if it was the time to get out of stocks. I asked him what stocks, in particular, he meant to sell. He said no stocks, just moving his retirement portfolio as a whole out of equities. I replied with several exclamation points — you can imagine the words that preceded the punctuation yourself.
“At the start of December, I addressed a roomful of high-net-worth financial advisors and asked them, ‘How many of you expect the market to fall more than 10 percent in 2016?'” said Allianz’ Hooper. “Nearly every hand in the room went up. And yet now that the market has experienced the sell-off, many are not viewing it as a healthy correction but are panicking and fearing the worst.”
Hooper said the psychology is easy to understand. Sell-offs are by nature disorderly and create a contagion of fear, and investors believe that when stocks go down 10 percent in value, there’s something “the market knows” but a Main Street investor doesn’t.
“In reality it is just a herd, and herding is a dangerous activity for investors,” Hooper said.
There is always a good case to be made for rebalancing from stocks that have run up a lot into stocks that seem undervalued. Maurer said it’s good to be “greedy” like Berkshire Hathaway chairman and CEO Warren Buffett through stock rebalancing. But when Lipper fund-flows data shows net negative flows in equity funds, that’s not what’s going on with the mass of retail investors.
Goldberg isa “big proponent” of raising cash at times, but said the time to do it is when stocks are rising and then wait patiently for new opportunities. “I never feel pressure to be fully invested at all times. But I do not believe in going to cash as an ‘all or nothing’ trade,” he said.
Cash proponents will argue that staying invested is a disaster-in-the-making for retirees. Goldberg said retirees are naturally the most fearful, but it’s the cash mentality rather than staying in equities that is the “never-ending wealth destroyer pattern.”
“You’re now giving up on an asset class that historically has been a hedge against inflation,” Goldberg said. “Sure, inflation is nonexistent according to headline statistics. But if you pay for health insurance, which as a senior could easily be sending a big proportion of your income on health care, you know you are ground zero for inflation pain.”
In fact, if any retiree has a portfolio constructed with investments that would collectively go to zero in a stock market correction, the only question worth asking is, Who designed your portfolio, and how quickly can you fire them?
There’s a reason that famed investors like Vanguard Group’s Jack Bogle and Buffett sound like a broken record with the“stay the course” mantra.
It’s not just because their millions and billions allow them to do so with comfort — though that helps.
14 Meaningless Phrases That Will Make You Sound Like a Stock-market Wizard
Media insiders will tell you that market pundits save their blushes when their forecasts prove to be wrong by using “weasel words” — slippery phrases that provide an easy out. In this article, the writer lists 14 meaningless phrases that can make you sound like a market guru with actually saying much.
Being a financial forecasting pundit often comes down to mastering a few meaningless phrases.
There’s no getting away from it. Market volatility tends to make investors feel uncomfortable, leading to knee-jerk decisions. Investor educator Brian Portnoy, CFA, Ph.D., recommends asking yourself at these times whether you are trying to resolve a long-term financial problem or a short-term emotional need.
Hello, volatility. It’s been a while.
As stock market investors, we should appreciate that we’ve had it relatively easy for years. It’s hard to understate how smoothly the equity markets have climbed since things settled down after the 2007-09 crisis. Since then, returns have been way above average while volatility has been way below average.
Profiting from a risky asset always involves a cost – a “price of admission.” That price is not only the uncertainty of whether the asset’s expected returns will be reached in the time frame relevant to us, but also the ride along the way. Contrary to the conventional wisdom of legends like Warren Buffett, Howard Marks, and Gene Fama, volatility is indeed a form of risk because lots of volatility often compels us to make bad decisions. (I’ll offer a full rant on that topic in a subsequent blog.)
Volatility’s return is a source of discomfort for all of us as it forces us to pay more attention to near-term market moves, which is mentally tiresome. And it tempts us to make more near-term decisions than we’ve been used to. It’s hard to resist counterpunching. In the moment, a rope-a-dope strategy means you’re getting pummeled.
Some basic tenets of behavioral finance can prove insightful at times like these. The goal is not to change your mental make-up – that’s impossible – but to appreciate that our hardwiring leads to some quirky behavior. Self-awareness can help us hedge bad decisions.
It’s the disposition effect that is top of mind for me now as I speak with financial advisors about how they’ve begun to brace themselves and clients’ expectations for choppier times. This effect states that you are wired to invest differently depending on whether you’re winning or losing.
We tend be to risk averse when we are sitting on gains and risk seeking when we are sitting on losses.
But why? The godfathers of behavioral finance, Amos Tversky and Daniel Kahneman, wrote in a 1979 seminal paper: “Our perceptual apparatus is attuned to the evaluation of changes or differences rather than to the evaluation of absolute magnitudes.”
To interpret the academics: It’s the journey that counts, not the destination. Life (and our portfolios) happens incrementally. So you measure progress based on where you now sit relative to your starting reference point.
Zero, it turns out, is a powerful reference point. When you’re ahead – great. But then we tend to sell winners quickly because we crave the psychic gratification of being right and the financial joy of booking a real gain. This is sometimes the wrong move, especially as stocks with positive momentum tend to keep going up.
On the other side of zero, we tend to feel the pain of losing far more than the joy of winning; this is the powerful notion of “loss aversion.” Thus, we’ll go further out of our way to avoid realizing a loss by holding on to a position in the red. Selling a loser? Boy, can that sting.
Realizing a loss renders us “officially” wrong. For advisors, that can prove to be a painful conversation with clients. Overall, advisor and client alike are often desperate to get back to scratch, even when it doesn’t matter much to the bottom line (“absolute magnitudes” to the academics). Sometimes, we’ll even “double down” – add more to a losing position – in the hopes of recovering from losses even more quickly. We look like a hero when we get off the ropes and land a haymaker.
With a more-heightened alert to choppier markets and the hard-to-shake feeling that we must “do something” during such times, please be cognizant of this disposition effect. It says nothing about the underlying value or risk in any of your investments. From a purely analytic point of view, there can be both good reasons to sell a loser (e.g., you were in fact wrong on the thesis) or to hold a loser (e.g., the value’s still there, perhaps even more so now).
But it does speak volumes when emotions trump analysis. Doubling-down, or any other number of trading strategies, might feel like the right thing to do in the moment. At those times, take a breath and ask whether you are solving for a short-term emotional need or a long-term financial problem.
The answer to that question will likely put you in good stead.
By Jay Franklin, Head of Risk at Index Funds Advisers (ifa.com), modified with permission by Ben Brinkerhoff
A hedge fund is a private actively managed investment fund that has the ability to take risks not allowed within normal managed funds, such as those used by Bradley Nuttall. Since they have permission to take these risks they are advertised as (but often fail to deliver on) dampening the risks of normal managed funds. The fees of hedge funds are extrodinary and those managers that beat the market consistently often become billionaires.
However, as a whole, hedge funds have failed to deliver their investors a higher return than US Treasury-Bills, according to a new study.1 But there are still a few that have provided stellar above-market returns. One of them in the United States is Steven Cohen’s SAC Capital, which is now the subject of an ongoing United States FBI/Security Exchange Commission investigation of insider trading that made the cover of Bloomberg Businessweek, in a very well-written article by Sheelah Kolhatkar. While it is too early to determine if Cohen will meet the same fate as another corrupt hedge fund operator – Raj Rajaratnam of the Galleon Group, who is currently serving an 11-year prison sentence – the FBI is working hard to get one Cohen’s underlings to turn on him.
As several have pointed out, consistently beating the market is usually the result of insider information. In trader jargon, it is referred to as a “black edge.” One trader turned witness opined that a hedge fund that refrained from using insider information would not be expected to survive. As Kolhatkar brilliantly put it in her recent Bloomberg article, “Trading on nonpublic material information is similar to doping in professional cycling: once someone like Lance Armstrong starts doing it, everyone else has to as well.”
So the prevailing question for any hedge fund operator is, “How do I get an edge so that I am not left behind?” One way, perhaps the oldest way in the world, is made apparent in a salacious ‘help wanted’ ad on backpage.com. Since I cannot do justice by quoting part of it, here is the whole ad (except for the contact information):
Secret Agents Needed
Do you have an open mind, a sense of adventure and the desire to make some serious cash? We’re a group that specializes in extracting key pieces of information from business leaders by seducing them with beautiful ladies such as yourself. Each assignment pays between $5k and $20k depending on the value of the information and how long it takes to obtain it. We also reimburse for travel expenses, if any. We have immediate needs for beautiful, sophisticated ladies who will do anything it takes to find out what we need to know! Please send photos and tell us something about yourself.
A few who followed the case in which corrupt hedge fund manager Raj Rajaratnam was put in jail will recall Danielle Chiese, the femme fatale who acquired information in the manner described above. She is now serving a 30-month sentence at the same federal prison that hosted Martha Stewart a few years ago, also in connection to trading on insider information. In one of her more colorful recorded conversations, she boasted of “playing” one of her paramours “like a finely tuned piano.” It is not difficult to understand why Forbes magazine designated hedge funds as The Sleaziest Show on Earth.
Bradley Nuttall advises investors that, rather than striving to beat the market, they should view the market as an ally whose returns are there for the taking. And finally, if anyone does come across material non-public information, they should contemplate how they would look in a prison uniform before acting upon it.
1Simon Lack, The Hedge Fund Mirage (New Jersey: John Wiley & Sons, Inc., 2012).
What Happened to 1 of the World’s Greatest Market Timers…
John Paulson is the multi-billionaire hedge fund manager and president of Paulson & Co.
He made one of the greatest calls of all time by short-selling subprime mortgages in 2007, earning him $3.5 billion.
As a result, he has developed guru, or cult-like, status.
With this fame has come new money, flowing in fast and furious into his funds and earning him a record $5 billion salary in 2010. Investors are only too willing to pour in their savings, expecting that his maverick predictions can earn them generous returns.
How could he get it wrong…he called the subprime meltdown?
Apparently nothing is more attractive to investors than the idea that you can pay someone to accurately predict the future and make a lot of money as a result.
Well, the guru John Paulson just submitted his latest regulatory findings. Paulson was expecting shares in Bank of America stock to reach $30 by the end of 2011. Instead, the shares dropped over the course of the year to around $5, at which point he sold (full disclosure: the shares bottomed out at $4.92.) Paulson’s big stake in the bank was one of several bad investment picks that helped lead one of his most high-profile funds to a negative 52.5% return last year, as reported by DealBook.
So far this year, Bank of America is up approximately 38%.
So, Paulson basically bought high and sold low. The www.BehaviorGap.com (and almost everyone else) calls that “Dumb!”
We’re sure that there are some hedge fund managers that made great calls last year and others that did worse than Paulson. Overall, according to Hedge Fund Research, the whole hedge fund industry lost money last year (down 4.8%), in a year when US Indexes were up. What’s crystal clear is that being last year’s guru is no guarantee of future success.
Yet the seduction of the successful speculator remains strong.
Why the heck is market timing so hard that even when people are paid billions to do it right…they can’t do it right?
Because you need to do the following:
Predict the future (nerds call this forecasting)
Predict that the future will be different from the consensus opinion
Be right way more often than you’re wrong (people don’t pay for average here)
Why do you have to predict the future “differently”? There’s no money to be made in having the consensus opinion. Prices already reflect that opinion. To make money you’ve got to bet on the price being wrong – preferably way wrong – and then make money when it ‘corrects’ according to your predictions.
We’re sure many of John Paulson’s investors, like others, are frustrated. What are they to do?
It may sound shocking but we first suggest giving up the idea that people can tell the future. Sure, we can all look at events happening today and say, “Hey, I think what’s happening today will lead to ‘this’ tomorrow.” But when you’re talking about investments, everyone is guessing tomorrow’s news based on today’s facts. Those collective expectations are factored into the price. To make money you have to know that the prevailing expectation is wrong. So really, it’s harder than just telling the future, it’s telling the future differently than everyone else and being right about it.
Who is “everyone else”? Everyone else is typically some pretty smart people who spend all day, every day, doing this or writing software to do it for them. John Paulson isn’t alone in trying to do this.
And here’s the frustrating thing: the prevailing view of the future is almost certainly inaccurate (it is the future, right?) but it seems to be randomly inaccurate.
What do I mean by “randomly inaccurate”? Basically the consensus opinion is such that there are about 50:50 odds its wrong or right. It has to be that way, or else a buyer and a seller would never agree on the price to exchange a share. Each have equal and opposite incentives, both are looking at the same publically available information, and both are free to transact however they wish. It’s only new information, not available at the time of the transaction, that will ultimately show who got the better end of the deal.
It looks like this time it was Paulson that got the worse end of the deal. We’re sure Paulson is not an idiot. He just couldn’t tell the future, and new information came out about Bank of America after he purchased that showed its prospects were worse than foreseen. You can’t blame Paulson for not knowing the future. But I believe you can blame him for acting as if he did… with a lot of other people’s money….people that paid him a literal fortune… people who probably aren’t very happy right now.
So if you give up prediction addiction, what are you left with? I suggest that you are left with investing for a long-term rather than short-term. You understand that in the long-run, bearing risk brings investment return as compensation. What if you don’t have a long-run time horizon? Then you take appropriate amounts of risk off the table by using a balance of more stable investments. Lastly, you focus on your goals, your savings and other things under your control. In doing so, you are bound to make many better decisions and be a whole lot less disillusioned.