Managing Your Expectations

 

By:  James C. Denton, CFP®, Managing Partner

March 29, 2021

This is going to be a long one but stick with me. I think you will find it worth the time, but I’ll put the bottom line up front.  Your appropriate take-away, or translation:   The performance you have seen over the past 12 months is far beyond anything in my experience, and in no way should it inform your future expectations.  That’s not a bad thing.  I’m not telling you the market is going down, I’m managing expectations, and your expectations going forward should be what I have always encouraged you to expect … The market has good days, the market has bad days, and the market has gone up, over time, with rational and responsible asset allocation and disciplined cash flow management, at an average rate of 8 to 10% [i].

I feel a need to address recent performance from a cautionary perspective.  I consistently refrain from offering actual performance statistics for three very good reasons.  (1) All performance is history, what’s coming is what matters, and what is coming is often completely uninformed by what has already happened. (2) There are many different variables, and different ways in handling those variables when calculating performance numbers, and without a detailed discussion of those variables, a performance number lacks the context to be properly appreciated, for better or worse.  And (3) every one’s individual performance is different based on cash flow and timing considerations, risk tolerance and goals and a host of other minor (or sometimes not so minor) details.

So what is different this time?  Well, with respect to these caveats nothing at all.  But this time, even when considering all of these details, we all had a very good 12 months.  The market-level numbers, were I to quote them, would blow you away.  If you want to, you can look them up.  Remember rule number 3; individual account results will vary depending on circumstances and conditions specific to the account, but I expect each of you will be more than satisfied when you receive your quarterly statements.

Now, keeping up when the market is going up is very hard to pull off.  We have to diversify, and if 30 to 40% of market performance is coming from 8 to 10 stocks, and we hold 30 or so (or a collection of mutual funds) in the typical account, it’s kind of hard to keep up.  We usually have our best comparisons, and I believe it’s what most of our clients really need if not expect, when the market is going down, and for the same reason.  The worst performance is usually restricted to a small group of issues, and responsible diversification mitigates, or at least is expected to hedge against the worst of a correction or bear market.

But this time, … I’ll be modest …  We did a pretty good job of keeping up in one of the best bull market runs in history.  So what’s the cautionary perspective? 

I have observed over the 30 plus years I have been in this business, we tend to be more impacted psychologically by more recent performance than we are by our own long-term results.  Rule number one notwithstanding, regardless of our nominal risk tolerance, recent events tend to be given more influence than they should in our attitudes if not decision making. [ii] 

So midway through the 2008-2009 bear market, for example, the prevailing fear, perhaps even expectation was that the carnage would continue indefinitely.  Of course it didn’t and it never has. 

On the other hand, the 2000 to 2003 bear market was a direct result of investor euphoria (“irrational exuberance”, in the words of Alan Greenspan in 1996) from a raging bull market that started in 1982, continued virtually unabated until 2000, and actually picked up steam in the last few months.  What was the cause of that late-stage euphoria?  The source of the irrational exuberance?  Investors’ expectations based on recent performance, for many of them the entirety of their investing experience, was that the good times would continue to roll.   And of course they never do.

And there’s the rub.  The reason the numbers are so very good right now begins with a severe mid-course correction this time last year.  The market went down about 35% in about two weeks.  A month later, it was well on its way to a full recovery, and the good times, they are a’ rolling.  Performance numbers are always a reflection of a “moment in time”, and the huge numbers you will see right now, if you look deeply enough or pry them out of me, are exactly that; an unusual and probably isolated recovery (i.e., will not continue at the same momentum if at all) from an unusual and probably (hopefully) never to be seen again unreasonably low starting point.   Rule number 2.

So, what the heck happened?  We could point to a host of economic and political considerations – the pandemic, the response by leadership, institutions, business, and individuals, the impact on business, and all of this would be a part of the story.  But ultimately markets are a response not to these factors, but rather to how investors interpret and respond to these factors.  In this market iteration we have seen two major investor reactions and responses have a significant impact.  We call them FOMO – “fear of missing out”, and TINA; “there is no alternative”.  Fear and greed.  Always, ultimately, the drivers of everything that happens in investment markets.

FOMO comes from the psychological reaction I mentioned earlier.  “What has been, recently, is what will continue, and I want to get my share.”  TINA is an assumption that the stock market is the only game in town.  The bond market is not a viable option.  Rates are exceptionally low, so no return on a bond investment under the best of circumstances, and it looks as if yields are changing directions and may do so radically.  If this trend continues the result will be (and has already been for many) loss of capital in an investment that has historically been seen as safe and stable.  They (bonds) are neither and investment advisors are starting to recognize and give heed to this imperative.  Hence, TINA, and everyone is diving into stocks.  Supply and demand in action.

And finally, just like in 1996 to 2000, the years after Alan Greenspan’s early but accurate diagnosis of irrational exuberance, there is a large cohort of new investors whose entire experience is the current bull market which began in 2009, or perhaps 2011 or even March of 2020, depending on how you calculate it.  These new investors have only their parents' recollection of 2000 and 2008, and their warnings to heed (just like ours warned us about the Great Depression).  And they are not paying any more attention to the warnings than you or I did. 

That’s history.  What should we expect going forward?  We posted an article on our website (see Industry Viewpoints) webpage last week that you should read if you haven’t already.  I agree largely with, and will not repeat the comments of that author whom I respect and follow from time to time.  But I will offer my own take briefly. 

There are very good reasons to expect that the current bull market, regardless of how old he is, has substantial legs.  The pandemic did a lot of damage to our economy, but a lot of good things came out of it as well.  There’s a concept in economic theory called “creative destruction”.  Stop me if you’ve heard this before, but the idea is there are always weak and non-profitable businesses that shouldn’t exist, aren’t worth investing in, but continue to provide jobs and economic activity.  The pandemic accelerated the demise of many of these businesses.  On the other hand, there was a change ongoing towards new economy businesses, and the pandemic jump started many of these activities, creating many new jobs that are substantially better than many that were lost for people who were already under-employed, and/or able to reinvent themselves for the new jobs.  The digital economy has long been recognized as the future, it is the 21^st century version of the Industrial Revolution and it is just getting started. 

So my prognosis:  This bull market could continue for a good long while and you have to be in it, but the market will have good days and bad along the way.  You should not over-react to or allow short term anomalies to shape your reactions or expectations in any meaningful way.  We can’t time the market and we don’t try.  We make decisions concerning individual stocks based on circumstances and considerations specific to those stocks.  And we’ve got a pretty good track record, so let me shut up and get back on that track.

One last point:  It is kind of hard to do any kind of investment commentary right now without acknowledging Bitcoin’s performance.  While digital currencies are not in any respect “securities”, their rapid increase especially over the past few months is siphoning funds away from the traditional markets.  I wrote a newsletter recently (see Focus on Bitcoin ) in which I seriously panned digital currencies.  My views have not changed, I continue to be suspicious – circumspect is probably a better word - of the long-term prospects. 

Nevertheless, it cannot be denied that some folks are making some serious profits (assuming they have sold and realized said profits).  If you’re dabbling in this sector, be careful; there have been some significant losses as well.  Any investment opportunity will have supporters, and there will also be those who don’t catch the vision.  The bulls will always find a reason to be bullish and when any “investable” is going up, the bulls will be encouraged, potentially unreasonably so.  (See previous discussion of “recent performance”).  Similarly, the nay-sayers (bears) will always find a reason to say nay, as nay-sayers are known to say.  The tension between the extremes is what makes a market, and whichever segment is getting the most traction at any given time is going to control the argument – for a season. 

But seasons (and circumstances) change.  Be aware.  Be cautious.  There are any number of potential events – outcomes – which could bring the bitcoin craze to a sudden and disastrous end … and in fairness, there are of course possibilities for continued fantastic success.  Don’t bet the ranch (or your retirement) and take some profits every now and then if you’re fortunate enough to be in a position to do so.  (Ask me about Enphase and Camping World next time we talk.)  But only the most aggressive players should have more than a token commitment to this particular segment.

 

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[i] Source: https://www.nerdwallet.com/article/investing/average-stock-market-return

[ii] This is one of the important benefits you get from a professional manager.  Our job is to bring an objectivity to the process that reduces the risk of over-reaction to the day-to-day noise and market events.  Individual investors seldom achieve market returns on their investments and this is the reason.  There is a very real and entirely normal impulse to sell when you should be buying and vice-versa, and it happens to us just like it does to you.  But the proper response, for you, is to simply ignore the daily goings on and stick to your long-term strategy and plan.  We do the worrying so you don’t have to.

The opinions expressed in this article are those of the author and may not reflect those of LPL Financial.  This material is for informational purposes only and should not be considered investment advice for any individual.  You should consult with your personal investment advisor before making any decisions from this material.

Past performance does not guarantee future results.  The economic forecasts set forth may not develop as predicted and there can be no guarantee that strategies promoted will be successful.