Season Investments

facebook-logo.pngtwitter.pnglinkedin-logo.png

Fear Of Missing Out

Posted on August 15, 2017

“The switch can flip from the fear of being in to the fear of missing out pretty quickly in the markets.” – Ben Carlson

2017-08-15_fomo.jpgSince the economy and markets climbed their way out of the dredges of the financial crisis there has been an exhausting volume of work produced warning of the next major market collapse. A large decline in asset prices is an obvious risk that many investors are all too familiar with, and as such it is the primary source of our care, worry and concern as investors. But what about the risk of consistently rising prices? What kinds of psychological and emotional impacts do stock prices have when they just won’t quit? 

The Dow looks to be creeping back up over 22,000 again today. This might explain why so many people seem to be commenting on “how good business must be” for us these days. What people typically mean when they offer that up is that US stocks are near all-time highs, therefore we and our clients must also, by definition, be experiencing similar peaks. The reality is that while business is in fact good, it really doesn’t have much to do with the Dow. 

What’s really interesting is that a strong Dow, in fact, can sometimes be a source of angst for us. The reality is that indexes such as the Dow, the S&P 500 and the Nasdaq represent only one of the many asset classes available to investors. Yet these indexes are reported on relentlessly, and they are mistakenly taken to represent “the market”. The problem with this is that most portfolios, both professionally and personally run, have at least some level of diversification built in. Everyone knows that stocks can be quite volatile, but diversification can serve to reduce the volatility of overall portfolio returns. One line of thinking says that you shouldn’t hold more stocks than you’d be comfortable holding through a bear market. There is a lot of wisdom to this in our opinion, for how many stories have we heard of people liquidating their stock market portfolios near the lows of the financial crisis – a decision that permanently impacted many peoples’ long-term financial situation. 

Diversification offers clear benefits over long periods of time, and especially during periods of severe market turbulence. That said, a necessary and known byproduct of diversifying a portfolio away from US stocks is that there will be tracking error between your portfolio and the widely followed indexes referenced above. If, for instance, a portfolio only has a 20% target allocation to US equities, then by definition the performance of the Dow is only relevant to 20% of your overall portfolio. 

In recent years the impact of diversification on overall portfolio returns has been disheartening, and our guess would be that most investment professionals are experiencing a tension between recent portfolio results and the seemingly relentless strength of large cap US equities. The chart below illustrates this by plotting the three-year price returns of five different ETFs representing five broad asset classes. As the chart shows, US Stocks have climbed by roughly 34% over the past three years, leaving all four of the other asset classes completely in the dust. Even international stocks, which typically would track much more closely with their US counterparts, lagged by over 25%. Bonds, meanwhile, were up 7% while commodities have gotten absolutely trounced, down over 30%. We also included a “managed futures” ETF in the analysis, which represents the efficacy of broad trend following strategies. Trend following, in theory, is designed to produce much more consistent positive returns in all types of market environments. But even this ETF was underwater by 8% over the past three years.

2017-08-15_diversification.png

The dynamic described above has been felt very plainly in our client portfolios, as we take the entire concept of diversification further than most in our industry. As a result, our portfolios tend to have less of an emphasis on US stocks and therefore experience less of a tailwind when US stocks go straight up like they have been. In this regard, further gains in the stock market may pose a unique type of risk to our approach. Most people wouldn’t consider higher prices a risk, but as Ben Carlson pointed out in the opening quote, sometimes the fear of missing out can take over and begin to drive our decisions. 

Michael Mauboussin, in a recent Credit Suisse white paper, uses the tech bubble as a great illustration of this dynamic: 

…investing is an inherently social exercise. As a result, prices can go from being a source of information to a source of influence. Take the dot-com boom as an example. As internet stocks rose, investors who owned the shares got rich on paper. This exerted influence on those who did not own the shares and many of them ended up suspending belief and buying as well. This fed the process. The rapid rise of the dot-com sector was less about grounded expectations about how the Internet would change business and more about getting on board. Great investors don’t get sucked into the vortex of influence. 

The current bull market in stocks is now the second longest in history, but that doesn’t mean that it won’t continue. We don’t know when the next bear market with start, or what will cause it. Regardless of what US stocks do in the coming months and years, it won’t change our view on the prudence of diversification. The absolute worst time to completely change your approach is following huge gains that you missed - or huge losses that you didn’t. The fear of missing out is a real emotion, and one that any investor should expect to experience from time to time regardless of their investment strategy. Good investors know how to regulate these emotions and keep them from becoming too influential in the decision making process.


david_headshot_bw.jpgAuthor David Houle, CFA is a founding member of Season Investments. He serves as the firm's Chief Compliance Officer as well as sitting on the investment committee overseeing the management of client assets. David spent nearly ten years in various roles primarily managing individual client assets prior to co-founding Season Investments. David graduated with a degree in Finance from Colorado University in Colorado Springs in 2003 and earned the Chartered Financial Analyst (CFA) designation in 2006. David and his wife Mandy have three children and spend most of their free time with friends and family.


Subscribe to our Weekly Insight via email!

 


Transparency is one of the defining characteristics of our firm. As such, it is our goal to communicate with our clients frequently and in a straightforward way about what we are doing in their portfolios and why. This information is not to be construed as an offer to sell or the solicitation of an offer to buy any securities. It represents only the opinions of Season Investments. Any views expressed are provided for informational purposes only and should not be construed as an offer, an endorsement, or inducement to invest.