“…investment advice is completely worthless when it’s not used within the context of an actual plan or well-defined process.” – Ben Carlson
There has been a lot of talk lately about the intensifying El Nino and what it could mean for the upcoming winter season. But as for us, our attention has been more focused on the violent storm that has already hit land, the one that has been moving through financial markets during the month of August. This storm strengthened dramatically last Thursday and reached fever pitch yesterday morning.
On the back of an 8.5% collapse in Chinese equities on Monday, European and American markets followed suit in one of the wildest trading days in years. We watched the opening bell with amazement as major indexes collapsed by 5-10% across the board. Large exchange-traded funds (ETFs) tracking well known indexes such as the S&P 500 disconnected with their net asset value and dropped like a rock by over 20% in some cases. Blue chip companies (think General Electric, Apple, JP Morgan, etc) swung wildly, moving back and forth in some cases by 15-20% within a matter of minutes. (Please note that I have resisted the urge to mention that the Dow was off by over 1,000 points in early trading…remember, we don’t pay attention to the Dow!)
Within an hour into the trading day the volatility had subsided and the market settled into a range for the rest of the day, with most indexes finishing down by over 3% at the close of trading. If you tried to find an article yesterday with a clear, concise explanation of what exactly was going on you might have noticed that the messaging was foggy at best. This is because the recent storm is not being driving by any one, obvious factor. The unusual behavior at the open may have been caused by computer algorithms triggering another mini “flash crash”, and there were also rumors of some highly-levered investment funds forced into selling mode after receiving margin calls. But at a higher level there are a variety of clouds hanging over the market, to include the uncertainty around a Fed rate hike, the popping of the Chinese stock market bubble and the collapse in commodities prices and commodity-exporting economies. Ironically, none of these factors have what we would consider a directly material adverse implication for the US economy and the financial assets tied to it. But this is a globalized, interconnected world, and when any major players begin sneezing chances are the others are going to catch a cold.
As investors these types of environments can certainly test our fortitude (see The Cost Of Being Human). Therefore, it’s important to put the volatility into perspective. According to JP Morgan, the recent bull market in equities went 1,418 calendar days without a 10% correction, the third longest such streak in the past 50 years. Since the “fiscal cliff” issues of late 2011 we have been in an extremely low volatility environment, at least comparatively speaking. This, combined with the fact that stocks were beginning to look richly valued, suggests that on some level we were simply due for a stiff correction in equity markets.
The chart below from JP Morgan also provides some fascinating context. The gray bars represent the calendar year returns for the S&P 500 going back to 1980, while the red dots represent the largest peak to trough declines experienced within each given year. Notice that even in the strongest up years for the market there was some level of volatility along the way. For instance, the very first year reflected on the chart (1980) shows a positive return of 26% for the year despite a 17% drawdown that occurred within that rise. For the current year this chart is only updated through July, whereas through yesterday the YTD return (gray bar) is a negative 6.8% and the drawdown (red dot) is negative 10.5% for the S&P 500.
The point in showing this data is that despite the harsh volatility of the past three trading days, there is nothing out of the ordinary going on here. Markets go up, markets go down. This is what markets do, and especially the stock market.
In times like this we want to continually emphasize the importance of adhering to the disciplined plan you’ve put in place for your investments. As far as our clients go, that plan entails diversifying their assets broadly across a lot of different asset classes (to include some that have been holding up quite nicely), and managing the risk in the Stock and Hard Assets markets via MarketVANE, our proprietary trend following model. MarketVANE has already gotten us out of the way of the bloodbath in commodity prices (see The Better Part of Valor), and if this garden variety stock market correction turns into something more pronounced it will also help us to stem the losses in stocks as well (see The Secret Sauce). Because we have a disciplined plan in place that we are confident will produce results in the long-term, we don’t have to run around second guessing every decision and looking for the next stock market prophet to tell us what to do. We knew the storm would come, so we put a plan in place to ensure that we would weather it.
Ben Carlson, in his recent article Things People Say During A Market Collapse, said the following in response to all of the “advice” that begins to fly around during major downturns in the market:
It’s just that any investment advice is completely worthless when it’s not used within the context of an actual plan or well-defined process. Trying to create a plan on the fly when markets are falling by mashing together a bunch of different tactics and sources of advice is a great way to make things even worse. And praying that stocks will rise in an uninterrupted fashion forever does not constitute a plan.
And although good advice is always important, when market volatility spikes, most advice gets thrown out the window as people start to run on pure adrenaline and emotions. If you have a plan in place you should be able to almost immediately recognize which pieces of advice make sense for you and your situation. That’s the whole point of setting reasonable expectations ahead of time and allowing for a wide range of market outcomes.
We couldn’t agree more, Ben. Whether or not this current storm intensifies or dies down and passes us by, we remain committed to thinking strategically, planning prudently and executing efficiently on behalf of each and every one of our clients.
Author 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.
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