Emotion can be inverse sign of next market trend
Daily headlines shouldn’t shake long-term strategy
Michael MaehlNovember 3rd, 2022
Last time we had a bad market was almost 15 years ago. And here we are again.
The year 2022 may be known for more than just the size of the losses in the stock market. According to Morningstar, this may be the first time that all 20 types of taxable bond funds have declined together in the same year.
Seeming to reinforce that, the percentage of bearish respondents in a recent weekly American Association of Individual Investors survey ticked up to 56.2%. The historical average bearish reading is just 30.5%, AAII says.
That survey, as well as the Investors Intelligence poll of financial newsletter editors, are each considered to be contrarian indicators. Elevated bullishness has historically meant investment risk is high while high bearishness can be tied to less risk.
As AAII itself states, “Above-average market returns have often followed unusually low levels of optimism, while below-average market returns have often followed unusually high levels of optimism.” History says the more pessimistic individual investors become, the better the prospective returns look six months out.
Or, as Jason Zweig observed, “Fear has always been the best fertilizer for future bull markets.” And, as Mark Hackett, chief of investment research at Nationwide, added, “Universal pessimism is bullish from a contrarian perspective, though timing of the pendulum swing is difficult to predict.” If you don’t bail, then you don’t have to be concerned by that timing.
It’s almost as though recent market activity has had the ability to completely shift the mood of investors. People magically became more optimistic after making a bunch of money over the past few years and now have fallen into despair after giving up some of those gains.
Today, the financial media would have us believe that stocks seem to be pricing in endless interest rate hikes as far as the eye can see; that inflation seemingly will never lessen; that earnings cuts, layoffs, crashing home prices and energy shortages are all imminent. The fact that these haven’t happened so far doesn’t deter the sky-is-falling crowd.
Maybe they’ll be right. However, based on almost 50 years of personal involvement in the markets, I’ll take the other side. History is in my corner.
Things can get worse, for sure, but rarely as bad as the worst that investors’ imaginations can create. And, at the market turn, the successful individuals or institutions of whatever size, will emerge even stronger than before this market environment.
Why? Because they’ll have kept cool heads and made good objective decisions—not emotional ones. For sure, not everyone will emerge unwounded, much less be in an even better position. I wish this weren’t so, but you have to focus on the things you can control.
Your time horizon is all that matters during corrections. Don’t put the money you’ll need for spending purposes in the next two years or so into risk assets, such as stocks. Instead, CDs, money markets, and savings accounts each can be used to store this money until it’s needed.
Given that most of your money is going to be invested for the long-term, whether you’re retired now or not, you need to understand that you’re going to have to endure future corrections, bear markets, and even a crash from time to time. That’s normal market stuff and, historically, has shown up around every five-ish years.
Understanding this and structuring your holdings over your time horizon can save you from becoming a forced seller.
Buy-and-hold requires you to do both when stocks are falling. It feels much easier to buy and hold when stuff is going up. But don’t bail just because prices are lower. If you choose to focus on daily market moves, you’re signing up to make yourself miserable. And for no good reason. A couple market day moves does not a trend make.
You don’t get huge gains without volatility. Many of the assets that had the biggest price gains in 2020 have seen considerable drops this year. There are plenty of stocks down 70-80% right now that were investor darlings during the pandemic. This is what can happen on the other side of outsized gains. Peloton comes to mind, as an example.
The perfect portfolio is worthless to you if you can’t stick with it when things are going poorly. It’s during corrections that you figure out whether you have a portfolio that suits your personal risk profile, time horizon, and personality—or someone else’s.
When you’re living through a correction, it can feel like your holdings are going to fall even further. Stocks fell 10%? “Of course, we’re going lower,” and 20% is next. Stocks fell 20%? Well, a 30% bear “must be” right around the corner. And, if stocks fell 30%? Now, it’s an all-out crash; just ask the financial media. FYI, a full-blown crash is not at all common and shouldn’t be your base case. If you think every bear market leads to a global crisis, you’re going to have terrible long-term returns and a ton of anxiety on top of it.
The benefit of you having a long time horizon is that you don’t need to nail the bottom when buying during a sell-off. And the truth is no one ever really nails the bottom anyway.
As mentioned earlier, if you buy the market, every sell-off in history has been a buying opportunity. I know. I’ve seen it happen since 1973. I know stocks can always fall further from current levels. Buying when prices are lower has always been a successful strategy—as long as you’re patient.
But the reasons for a correction don’t really matter in the grand scheme of things. Sometimes stocks go down. Period. It just happens. You don’t know when, and you don’t know why, but you should know it’s going to happen.
Here are some points I believe you should also be considering in this market:
•The risk of holding cash has simply become too high. You’re never going to catch the bottom. No one ever does, so stop worrying about it.
•If you’re holding any significant cash for any serious long-term goal, this is the time to start putting it to work.
•This massively universal bearishness can’t be very right for very long. It only seems like it when it’s happening.
•If you invest now, and the market goes down 20% from here, you may regret that for a matter of months. However, if the market runs away from you, and you freeze, you may end up with expensive longer-term regrets.
You can focus on what actually matters when it comes to investing. And that’s time. A very long time—as in multiple years.
Long-term strategies to lessen risk to your long-term retirement portfolio include saving more to provide a larger buffer, diversifying your portfolio across different asset classes, investing in dividend-paying stocks, and considering a guaranteed source of income for a portion of an overall portfolio. Guaranteed sources of income, like annuities, can help ensure that you have money that can last throughout retirement.
We’ve been through markets much worse than what we’re dealing with today. Don’t let the headlines damage your retirement.
Michael J. Maehl is a Spokane-based senior vice president of Opus 111 Group, a Seattle-based financial services company. He can be reached at 509.944.1790.