Investing in 2019: 7 Lessons for Volatile Times
"The first lesson of economics is scarcity: there is never enough of anything to fully satisfy all those who want it. The first lesson of politics is to disregard the first lesson of economics."
Thomas Sowell, American economist
Late 2018 and early 2019 have been a more challenging experience for asset market investors than most of the past decade has been, given wide intra-day swings. The worst December in 87 years was followed in rapid order by the best January in nearly three decades, leaving many participants with a bad case of whiplash.
The popular press credited economic and political issues as the root cause of the volatility. However, we hesitate to ascribe too much fundamental forethought to the trading activity during the final weeks of December and suspect a number of non-fundamental factors contributed to the whipsaw action. These include algorithmic trading, year-end tax loss harvesting, and a dearth of traditional liquidity sources.
While the economy and the markets powered strongly through much of 2018--including several notable technology stocks that briefly sported $1 trillion market caps in early fall--the market gains were all erased in a heart-wrenching, hand-wringing final few weeks.
As 2019 has begun, it seems to us that domestic markets have settled into a fairly constructive mindset. Acute concerns over trade tensions and the government shutdown have cooled (for the moment) as headlines alluding to developments in key areas seem to be greeted with optimism, or at least not with disdain. Domestic markets have regained much of the ground lost late last year, while traditional indicators of either excessive optimism (ebullient investor or business sentiment, elevated valuations, overpriced acquisitions, rampant IPOs) or excessive fright are notably absent.
While markets have stabilized and most economic statistics are registering readings supportive of a reasonably healthy economy, both uptrends are long in the tooth. We remain overweight in equities and growth-biased in our positioning, though watchful of a variety of indicators that might hint at the next downturn's imminence. Given this combination of factors, it may be an opportune time to pause and reflect upon how the intensity of late 2018 affected your comfort with how your portfolio is constructed. Toward this end, we offer up a few of the lessons that can be gleaned from what just occurred.
- Lesson 1: Volatility is normal. Although it is exceedingly uncomfortable, especially when we haven't witnessed it in a while. As reported in Bloomberg Markets, the first 10 months of 2017 had 8 days with a 1% gain or loss, while the same period in 2018 had 48 such days! If you were left feeling nervous, sleepless, and overly concerned, it might be time to reassess your public/private or stock/bond mixes.
- Lesson 2: Stay focused on the fundamentals. Short-term volatility can be (and, more often than not, is) caused by structural and emotional issues rather than thoughtful reactions to long-term fundamental changes. It's tough to turn the U.S. or global economies on a dime. The trajectory of the U.S. economy has basically been upward since its founding, and stock markets tend to represent the best and brightest of this economic trajectory over the very long pull.
- Lesson 3: Market timing typically doesn't work. Market timing is difficult because it requires precision on at least two decisions: when to get out and when to get back in. A third decision--where to park proceeds--further complicates the issue, as do trading costs and potential taxes. Having a long-term allocation that feels durable no matter what the environment, and then using volatility to trim overvalued assets and round up on undervalued ones can help straddle a variety of potential outcomes.
- Lesson 4: Ensure that your spend rate is sustainable. And ideally, that larger future liabilities are decked against specific assets (e.g., bonds/cash). Knowing that a bulk of your annual spending needs are provided for by dividend and interest payments or against a pool of short-term fixed income can make swings in the more growth-oriented parts of your portfolio more tolerable.
- Lesson 5: Focus on what you can control. That is, taxes, turnover, costs, and allocation, versus what you can't (headlines). If markets and economies are upwardly biased long term and you have patience, participation should have the upper hand.
- Lesson 6: Dollar cost averaging can help you get "unstuck." The funding of new accounts, or dealing with the need to reduce large concentrations in specific sectors or stocks, can prompt one to freeze with inaction for fear of making a "wrong" decision, especially around timing. The fear of regret is a powerful motivator. One way to address this is to "schedule" dollar cost averaging in or out, although this strategy does not assure a profit or protect against a loss in declining markets.
- Lesson 7: Short-term markets can be exceedingly emotional. Greed and fear aren't the only two emotions that drive markets. As emotional turning points are neared, volume tends to get heavy, and investor emotions can run excessively complacent, greedy, or fearful. Fundamentals get tossed and our hardwired "fight or flight" responses tend to kick in. It's vital to remember at these points, though, that we are the only creature with the capability to insert a "pause" between stimulus and response. In that pause, it's helpful to reassess your investment objectives, understand why you are investing in the first place, and what you want your funds to accomplish over the long pull.
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