Market Update & More (3/15/2020)

Q. How about that stock market rally on Friday? It has to mean Thursday was the bottom right and this was that quick turn you’ve talked about before?

A. Honestly, I doubt it. And I don’t mean that stocks are going to immediately just give that all back, though they certainly could. What I mean is that the stock market is constantly adjusting to price in all known current information and all opinions of those who are invested in it. If the average investor thinks that prices for a company, sector, asset class, country, index, or the market as a whole are too high, then that average investor will be buying less at the current price than selling. That makes prices fall, sometimes rapidly, to a lower point where equilibrium is established again. The reverse of course is true as well. If the average investor, known all they know, thinks prices are too low, then there will be more buying than selling at the current price, thereby pushing prices up. Right now, markets are getting lots of new information daily, sometimes minute-ly (don’t think that’s a word, but let’s go with it anyway). Opinions form, sometimes overreacting, sometimes underreacting, though we never know when that’s the case. Friday’s snap back from Thursday’s ~10% move down is more shifting opinions, more new information, and more projecting the future beyond covid-19 and an oil price war. The odds are good that the market is still fairly priced and if it’s not, we don’t know whether it’s overpriced (near term shock will be worse than expected, recovery longer, long-term impacts) or underpriced (near term shock will be better than expected, recovery shorter, few/no long-term impacts). The key part of that last sentence is “than expected”. We can’t simply read the news, say that covid-19 cases and deaths increased, and think that would cause stocks to lose value. What causes stocks to lose value is when things are worse “than expected”, in aggregate, and that worse than expected result is validly projected into the long-term future. No one can tell you when the stock market is going to bottom or has bottomed, just like they can’t tell you when it is going to top-out or has topped-out. It would be much wiser to say that the best guess is that the market is fairly priced, is most likely to produce average returns from here, but that the likelihood of a wild swing in one direction or the other remains.

Q. Well, that’s disappointing. Everything’s so depressing right now… can you give me a few positives as a result of what’s happening?

A. Absolutely.

  1. Long-term interest rates are extremely low. That’s not just great for refinancing personal debt (e.g. mortgages), but it also means something important about asset prices. A company’s value today is determined by a projection of its future profits, but typically the short-term profits are weighted much higher than long-term profits because of the interest rate you can earn on those profits each year as they’re collected. If interest rates are high, say 10%, you’d rather have a dividend right now and reinvest it at 10% than get it five years from now. That makes the short-term much important relative to the long-term in determining current value. When interest rates are as low as they are now, the value of the next year’s profits is a much smaller portion of a company’s total value. This is extremely important in the sort of scenario we’re living in now where the disruption to profits seems temporary. Losing year one of profits with minimal/no impact on years 2 thru infinity should not change current value by that much, at least not in aggregate (individual company’s might have debt which forces them out of business if they can’t make payments, but then another company that survives takes their revenue going forward). Warren Buffett invested in an airline yesterday. I suspect, he’s using this kind logic in buying the worst possible investment for news flow (ex-cruise lines), at exactly the worst possible time looking at near term profits.
  2. Gas prices will likely be in the ~$1.50 range nationwide in the next couple of weeks. Most people aren’t doing a lot of commuting / traveling right now, but when they do, those cheaper prices at the pump add up to more money in consumer pockets.
  3. More on interest rates… I don’t know if we’ll do this, but the country has an opportunity to extend the maturity of short-term debt to the very long-term without paying much higher (and sometimes even lower) interest rates. Some countries have 50-year and 100-year bonds. For some reason, we don’t go beyond 30. If we could refinance our national debt at low, fixed, long-term rates, it will give some leeway to fixing our fiscal issues.
  4. We’re going to be able to refill the strategic petroleum reserve for the US at prices that seemed unimaginable 10 years ago. The next time there is an oil supply shock, we’ll be much better positioned as a result. (Aside: shouldn’t we also have a strategic medical supply reserve? *sigh*).
  5. For those who are still adding to their portfolios, which are generally the ones that will take the biggest hit from stocks falling in value since retirees don’t have all their money in stocks, the opportunity is substantial. I don’t mean that stocks are a fantastic opportunity now and they should pour money in at current prices. But, investing steadily through the rollercoaster will get you to a higher ending portfolio value than investing the same way in a market that just moves steadily upward. See for examples.
  6. The worldwide fiscal and monetary response to our current challenges is going to be enormous. This has some long-long-term consequences, but for the medium term, it can’t be anything but a positive. The last decade has also made it much more commonplace and acceptable for the Federal Reserve to pump money into the economy to replace a lower velocity of money due to forced deleveraging. Quantitative Easing (QE) takes a lot of credit for keeping us out of Great Depression II following the financial crisis. There’s a fair chance an even stronger response could come this time if things get dire. Did you know that Japan’s equivalent of the Federal Reserve purchases equity ETFs (i.e. stocks)? Our Fed doesn’t have that mandate from Congress, but I wonder what happens when a national emergency is declared and the president has broader executive order powers? Hmmm…

Q. I feel a little better. Still though, from a financial standpoint, there are tons of people on CNBC and other stations saying they don’t want to be in stocks right now and haven’t been in stocks while this was happening. What do they know that we don’t know?

A. There are lot of doomsayers out in the press right now, taking victory laps because the market is down, even though many haven’t been bullish since before the great financial crisis. Maybe some of you reading this fall into that camp internally as well, feeling like you knew this was going to happen, but thinking back, you’ve felt that for so long that if you had acted at that point, you would have missed out on much more growth than you have lost in the last month. Still others may have nailed their “top” call at exactly the right moment. Surely you will be hearing from them at times like this. There are a lot of people in the world making predictions though and if you frequently make bold ones, you’re bound to be correct and may even find yourself on TV celebrating it. CNBC presents cheerleaders when markets are doing well, calling on people to buy hand-over-fist and perma-bears proclaiming the end of the financial world during a crisis. It’s what gets ratings. It’s also the people who are willing to come on their shows since they’ve been recently correct. It’s not hard to find people who are correct, even several times in a row… If you flip 10,000 coins 10 times, odds are that about 10 of them will come up heads every time. It doesn’t mean the coin has an advantage over the other coins. It means you’re not hearing from the other 9,990.

Q. How do you stay calm about all this? Aren’t you worried at all?

A. In all honesty I have my moments of personal freaking out at times like these, just like many of you that are reading this. Like the old Hair Club For Men commercials for those of you who remember them, I’m not only an advisor, I’m also a client. It’s ok to let yourself feel emotion. It’s just not ok to act on that emotion and do something that you planned specifically not to do exactly in a case like this. I know I signed up for riding a long, upward-sloping roller-coaster the first time I invested. I know with almost certainty that there will be dips of 50% on this ride, with the possibility of more from time to time. I know that it won’t look upward sloping during those dips. I also know that investing in aggregate in the ingenuity of humans and the ever-rising productivity and technological growth of our society is the best way to build long-term wealth. It is the reason why the roller-coaster slopes upward over the long-term. I also know that money I may need in the short-term isn’t invested all in stocks and in matching that return/risk profile with my family’s goals, there’s really nothing to worry about over the short-term. I still worry because I’m human, but my plan gives me comfort. I also sometimes feel like I know what the stock market is going to do (especially in hindsight!!!). During the financial crisis, I convinced myself I knew it was going to happen (in truth, I knew real estate couldn’t rise 15% forever, but I had no idea the depths that we’d be going to in early ’09). I knew after the sharp rise in stocks in spring of ’09, that we were going to revisit those lows again (we didn’t). I knew that the Fiscal Cliff disaster was going to crash the market (it didn’t). I knew that the financial system was going to crack when Europe ex-Germany was inching closer and closer to defaulting on their government debt (it didn’t, and not only didn’t it, but that government debt turned out to be one of the best investments ever for those who bought at the brink of disaster). Now, I’ve had good internal calls as well over the years, but I remind myself frequently about that coin flipping that I mentioned above. In short, I give myself time to freak out, I moan and groan, I remind myself of the futility of market-timing, I pull myself together, and I get back to regularly scheduled life. If any of you, my clients, find yourself stuck between freaking out and getting back to regularly scheduled life, please call me. I’m also a client and I know what it feels like. It’s the reason I write these posts when times are tough. I’m talking to me as much as I am to you. And, I’m listening.

Market Update (2/5/2018)

I had hesitated to send one of these out after the two-day pullback in the market because while it looks bad on a point basis (Dow, S&P, etc.), it’s far from exceptional on a % basis, which is what counts. After today’s fall, the S&P is down a little over 1% for the year. Some other assets classes are down a bit more, others are still up on the year. This is far from “Markets in Turmoil”, but that business news headline attracts attention, raises fears, and up go ratings. Because of that, I thought a quick note was warranted to both show there is not turmoil at this point and to give you my perspective on what’s going on. Here’s a quick look at year-to-date performance (including any dividends paid) by asset class (representative ETF) AFTER today’s “plunge”:

US Large Cap (SPY): -1.1%

US Small Cap (VB): -2.7%

Foreign Developed (VEA): -1.5%

Foreign Emerging (VWO): +1.7%

Real Estate Investment Trusts (VNQ): -9.9%

High-Yield Bonds (HYG): -1.3%

Aggregate Bonds (BND): -1.4%

Short-Term Investment Grade Credit Bonds: CSJ: -0.1%

Local Currency Emerging Market Bonds: +2.5%

Aggregate Commodities: +0.5%.

As you can see, with the exception of REITs, which are getting beaten up as interest rates rise, this is far from turmoil.

What happened today is concerning though. Stock markets behaved erratically. Futures liquidity dried up as this started to happen and liquidity in the S&P 500 futures contracts after-hours tonight are as low as they have been in a long time. That means it’s fairly easy to push the market around with relatively small orders, causing big moves in either direction. As a result, S&P futures have been moving 10+ points repeatedly over only a few minutes throughout the evening (this is the equivalent of the Dow moving in about 100 points per few minutes). The markets are down sharply overnight, with recent lows having Dow futures down another 1100 points from today’s close and S&P futures down a little over 100 points. This isn’t being caused by economic issues, bank liquidity issues, terrorism, recession, or anything that caused the last two major (-50%+) market falls. In my opinion, it’s being caused by large, leveraged bets on continuing low volatility which are unraveling in what should have been some mild profit-taking and re-pricing as interest rates moved a bit higher in January. Volatility has been running well below normal as I’ve pointed out in recent quarterly updates. Futures markets generally price in a return to normal volatility over time. Therefore, if one shorts future volatility in futures markets (or via multiple exotic ETFs and other financial products) and volatility remains low, money can be made over and over again very quickly. Hedge funds have been started that engage in this tactic and it has paid off massively over the past year as there has been virtually no volatility in the stock market. The longer the strategy pays off, the more money moves into it, chasing its success. People / funds begin to borrow money to invest in the strategy (leverage) because they can pay a few % of interest per year for their borrowing costs and make 10%+ per month if the strategy continues to do well. For all of history this has been a recipe for disaster and sure enough, it is beginning to unravel. An otherwise ordinary increase in volatility surrounding a few days of rising interest rates / declining stocks causes these bets on low future volatility to lose massive amounts of money very quickly. Fear that they won’t be able to pay back their loans causes margin calls which forces more selling of this strategy. Selling of short volatility funds is essentially buying volatility into a spike in volatility, which causes (of course) more volatility. Other hedge funds know this is happening and try to take advantage of the forced volatility buying (stock selling) causing even more. From there, it’s the same old vicious cycle that has fueled market drops like this in the past. Want proof that this is what’s going on? Today was the single biggest % increase in the VIX (the volatility index) in the history of the market on what wasn’t even in the top 100 down days on a % basis in the history of stocks. Want more proof? Here’s the after-hours chart of an exchanged traded note that tracks the inverse of the volatility index (I know that’s a mouth-full… it’s basically one of these short-future-volatility funds that is blowing up):

You’re reading that right… -86.04%, just since 4pm today! This is going to cause some hedge fund meltdowns. It’s going to cause some margin calls. It’s going to strain markets for a while. But I find it hard to believe an obscure greed-based strategy is going to bring down earnings growth, which is really starting to pick up around the world. That’s not to say there aren’t other factors playing a role here, but I think this short-volatility blow up is a big part of it. Another cue that this is probably a shorter-term event is that it’s not flowing through to currency markets at all (at least not yet). Despite futures being down 4% overnight, the dollar index, a normal flight to quality when there is a lot of fear in the market, is up only 0.1%.

Anything is possible, and as I’ve said many times, I’m certain that the stock market will eventually fall more than 50% again. We probably won’t see it coming in advance of that happening. But, if someone forced me to place a bet, I would bet that this will be a fairly short-term event that will allow the market to build again from whatever bottom that forms. To be clear, I’m not advising anyone to invest money they wouldn’t otherwise invest as a result of this. I’m not advising anyone to be more aggressive or conservative in their portfolio or to reposition assets in any way (other than usual rebalancing) as a result of this. Financial plans are designed to weather market moves, not predict them, and not time them. I know seeing your portfolio value fall hurts. For some of you, it makes you want to sell stocks. For others, it makes you want to aggressively buy stocks. But it is going to happen over and over again and is the price you pay for the kind of growth you’ve experienced over the past several years. Markets can’t only go up, despite what they’ve done in the past year. We’ll be rebalancing client portfolios on the way down (sell bonds, buy stocks), just as we rebalanced in the other direction (sell stocks, buy bonds) on the way up. And, it never hurts to have your planned contributions and 401k deposits go in at a lower level than they otherwise would have.

In short, expect that wild swings in either direction are possible over the next several days. I hope that with the explanation above, you’ll find what happens more interesting than traumatic. As always, if you’re reading this as a PWA client, feel free to contact me with any questions.


As I type this message, the votes are being counted in the UK referendum on whether to remain in the Euro zone or exit (British Exit, “Brexit”). With approximately 2/3rds of the voting areas reporting, the result looks like a narrow victory for the exit camp. This comes as a total shock to the financial markets, which had been pricing in a win for the Remain side, based on recent poll data, and similar votes in other countries in recent years. Virtually all economists are in agreement that this will have a detrimental impact on UK GDP, at least in the short-term, and maybe in the long-term. It also signals a possible unraveling to the Euro zone if other countries reach similar decisions. The future impact is all based on speculation at this point. Is it better for the UK to extract itself from a potentially failed experiment in trying to combine countries in Europe that are too culturally different to be combined, even if there is some short-term economic pain? Might it even be better for the world if the countries of the Euro zone all return to their previous status as completely separate entities that are not as dependent on each other? Or does the obliteration of trade agreements, a common currency, and a determination to become more unified wind up hurting global growth irreparably? No one knows these answers.

What we do know is that when financial markets are shocked by an unexpected event that MAY have major economic implications for the future (MAY emphasized, because whether it does have those implications or not is irrelevant), volatility ensues. In this case, it is led by the currency markets as the value of a British Pound can change dramatically if the market in aggregate believes now that investments in the British economy will offer poorer returns in the coming years than they did yesterday. Major swings in one currency often trigger major swings in other currencies in a rush to safety (US Dollar) and away from riskier and higher yielding currencies. Currency swings impact the economies of the countries that use those currencies. Currencies that depreciate in value gain an export advantage over other countries, but the cost of imported goods can rise sharply and hurt more than the exports can stimulate growth. Stock market fluctuations follow from the economic impacts and volatility there can be self-fulfilling as leveraged losing bets cause additional forced selling via margin calls and fund liquidations. In financial markets, fear begets fear. As you might expect, the British pound is incurring substantial declines in overnight markets… currently down almost 10% vs the US dollar, back to levels not seen since 1985. World equity markets are also suffering, with US markets down 3-4%, the UK down 7.5%, and Asian markets down as well. US bonds are a bright spot, as is almost always the case in situations like this, which is the reason we include bonds in your portfolios even when interest rates are low. They are a source of stability and are negatively correlated with other assets.

While it’s always possible that there will be a quick snap back rally, events such as this tend to take a while to play out in the markets as bottom-pickers try to time their bets (exerting buying pressure and causing a rebound in prices), while funds with liquidation requests and leveraged bets that led to margin calls force additional selling (downward pressure) on the markets. As is usually the case, the market knows best what a fair price is given the current situation, so we don’t see this as a reason to panic and sell, or a particular “buying opportunity” beyond the investing of spare cash that you should always be doing and that’s part of your financial plan. It’s merely something that has now happened and is priced into the markets. Over the long-term, the economic impacts will play out, and prices will continue to adjust as those impacts are better understood.

The long and short of Brexit is this: tomorrow is likely to be a very ugly day in most financial markets. The gains of the last few months are likely to be wiped out (and then some). Will that change the fact that over the long-term, populations will continue to grow, people will continue to work, and productivity will continue to increase through process and technological advances? Call me skeptical, but I doubt it. The world’s economic output, in all likelihood, will continue to grow over time and we’ll look back on this as yet another event in the history of financial markets that caused a lot of headlines to be written and a lot of fear to swell over a temporary blip in overall growth. We have no idea whether the UK will benefit or be hurt by their democratic decision (if they even go through it). But the world as a whole will be just fine after some time to adjust to the new landscape. In other words, I sincerely doubt any of you will be telling your grandchildren that their lives would be so much different if only 2% more of the UK voted to stay in the EU on 6/23/16.

The Value Of Volatility

When the market falls, especially after a strong upward run (4+ years in this case), I think it’s worthwhile to remind everyone about the value of volatility. To keep it simple, let’s just think about a simple portfolio containing all US stocks and no bonds. This is what I would consider to be an extremely aggressive portfolio, one that would be hit very hard by a bear market like we had from late 2007 to 2009. Let’s look at 2 cases, with the stock index in both cases shown in the graph below:

Case 1: Reality (Volatile Market) – Using the actual performance of US Stocks from late 2007 to the end of 2012, suppose you had a $100k portfolio in September of 2007, just before stocks peaked and started heading lower. Your financial plan for retirement called for $1k per month contributions consistently (think of this as your 401k for example). The market tanks, losing almost 50 of its value by March 2009, and then slowly comes back to surpass where it started. By the end of 2012, you would have amassed a sum of $196,024.60. That’s your original $100k + $63k in contributions + over $33k in gains.

Case 2: “Ideal” (Market Never Falls) – In this case, we’ll pretend that the stock market moved in a slow straight line starting at the same value as in Case 1 and ending at the same value as in Case 1, but with no volatility. It never had a losing month and just kept slowly increasing. Let’s start with the same $100k and add the same $1k per month. This would feel much more comfortable. You could look at your statement and see constant progress… slow and steady. No sweating, no heartburn, no temptation to sell or alter your contributions. I call this the “ideal” case in quotes, but it’s actually far from ideal. In this scenario, you would have ended 2012 with $180,931.30. Again, your original $100k + $63k in contributions + ~$21k in gains. That’s only 2/3rds of the gain with the volatile portfolio, simply because you never get to add your $1k per month at lower prices.

The moral of the story here is that if you’re adding to your portfolio regularly, you really should be hoping for the market to fall from time to time, not rise, so that you can buy at lower prices. Sure, you want the market to rise right before you need to withdraw money, but until then, the lower it goes (a la March 2009), the worse it will feel, but the better it will be long-term. Volatility is the real “ideal” for the long-term investor.

Volatile Markets & Active Trading

***This post was originally published in PWA’s Newsletter: The Pretirement Press in Q1 2008 and it’s publish date has been edited here to reflect the approximate initial publish date***

The sharp up-and-down in the markets tends to draw more market-timing traders in. These speculators attempt to profit from momentum by buying when the market is going up and selling when it’s going down, creating even more of a whipsaw effect. For the inexperienced investor, it can be tempting to try to pick a top or a bottom in the market and profit from these wide swings. There are four issues with doing this.

1) You need to pick the right top to sell your investments and if you’re wrong you risk missing the upside.

2) You need to pick the right bottom to buy back into your investments.

3) You need to pay taxes when you sell (assuming you have gains), which means you’ll be unable to buy the same amount back later.

4) You pay commissions to your broker each time you make a trade.

Brokers will win with this strategy since they collect trading fees. Uncle Sam will win with this strategy since he collects taxes. A few individuals will win with this strategy if they pick the exit and entry points correctly. Everyone else will lose, and will experience much more long-term volatility than necessary. A much more successful strategy is to work with your advisor to outline your goals, the returns you need to achieve those goals, and implement an asset allocation that is designed to target that return over the timespan you need. You can’t measure it over months, you won’t get the exhilaration of a “winning trade”, and it won’t be as much fun to try. What you will get is enough money to fund your lifelong aspirations and that should be much more meaningful than occasional short-term wins.