Despite lots of twists and turns – and a horrendous third quarter – the S&P 500 is still up for 2023.
Yet, as I mentioned in Friday’s column, the vast majority of stocks are down for the year.
And that’s after last year’s 18% market plunge.
Some market pundits insist that it’s just a matter of time before higher bond yields – and more interest rate hikes from the Fed – torpedo the economy and, ultimately, the stock market.
Those fears were magnified over the weekend after Hamas launched a surprise attack on Israel and the country declared war, announcing a “total siege” of Gaza this morning.
Is it time to panic?
No. Smart risk management is about dealing effectively with the uncertainties that face the economy and the market.
Let’s do a reality check here. Trees don’t grow to the sky and stocks don’t rally in perpetuity.
History shows that every bull market is eventually followed by a bear market.
And that’s okay because every bear market is eventually followed by another bull market.
Look at the past 200 years. The market’s long-term trend is higher highs and higher lows.
As for all those confident short-term prognosticators, recall what Peter Lynch, the legendary manager of the Fidelity Magellan Fund, wrote in his investment classic One Up on Wall Street:
Thousands of experts study overbought indicators, oversold indicators, head-and-shoulder patterns, put-call ratios, the Fed’s policy on money supply, foreign investment, the movement of the constellations through the heavens, and the moss on oak trees, and they can’t predict markets with any useful consistency, any more than the gizzard squeezers could tell the Roman emperors when the Huns would attack.
In my experience, the folks who shout the loudest that the end is nigh for stocks have a long history of making that same prediction… over and over.
All they have to show for it – aside from the inability to feel embarrassment – is the yolk running down their faces.
As Vanguard founder John Bogle noted, there are two types of market timers: those who don’t know what they’re doing and those who don’t know they don’t know what they’re doing.
Remember that the next time you hear some CNBC contributor confidently pronounce “what the market will do next.”
Given the uncertainties inherent in the market, what should sophisticated investors do? Two things:
- Have a battle-tested plan.
- Stick to it, responding unemotionally to market volatility.
Long-term investors should realize that bull and bear markets are a fact of life.
They should set an asset allocation – as The Oxford Club does – and stick with it.
That means every year they pare back those asset classes that have appreciated the most and add to those that lagged the most.
(Again, I’m referring to asset classes – equities, bonds, real estate investment trusts, TIPS, etc. – not individual stocks. You should definitely NOT add to the worst stocks in your portfolio.)
Rebalancing doesn’t just reduce portfolio volatility. It forces you to sell what’s high and buy what’s low. That gooses annual returns.
A short-term trader, on the other hand, uses a different sell discipline.
In the case of The Oxford Club, it means trailing stops. They protect your profits in the good times and your principal in the bad.
However, you must actually implement stops rather than just imagine you will.
Some investors so detest taking small, short-term losses that they end up with big, long-term losses instead.
Occasional losses are unavoidable.
A short-term trader who thinks he can avoid them is like a running back who imagines he’ll never get tackled.
Some investment ideas – maybe even a few that you feel best about – simply won’t work out.
That’s why the best investors follow through on their discipline.
If you can’t do this, you may need to turn your portfolio over to a trustworthy, low-cost investment manager.
(As Clint Eastwood’s Dirty Harry Callahan famously said, “A man’s got to know his limitations.”)
I’m not suggesting you shouldn’t feel emotional from time to time when the market starts to swoon, as it has lately. That’s too much to ask of flesh-and-blood human beings.
But you can’t act on fear and anxiety and expect to prosper over the long haul.
Some will rationalize – as they run to cash – that they will get back in later, when the outlook is better.
But the outlook is never better at the bottom. If you wait for the robins to appear, spring will be over.
So fight the urge to flee stocks whenever they get volatile.
History demonstrates that the key to long-term investment success is not doing things that are brilliant.
It’s avoiding the things that are foolish.