Broker Check

Meritage Periodical - July 2022

Advisor Perspective

Prompting critical thinking and conversations around issues in our industry. Not intended as personal financial advice.

"History does not repeat itself, but it often rhymes."

-Attributed to Mark Twain

If market declines make you nervous, you’re not alone. Since COVID-19 arrived, we have been dealing with an unparalleled level of uncertainty. The virus persists and society struggles with the shift from pandemic to endemic. Russia and Ukraine are at war. Also, for the first time in over 30 years, inflation has shifted from an academic risk to a real and present danger. So, is what’s ahead something different from what we’ve seen before? We feel it’s incredibly important to ask this question. To answer the question, we started by asking ourselves whether what has happened so far is logical.

On March 11, 2020, the World Health Organization declared COVID-19 a pandemic. Almost immediately, the CBOE Volatility Index ("the VIX"), otherwise known as “the fear gauge,” jumped from about 15 to over 80. As we shifted out of lockdowns, the volatility index declined, but has remained at elevated levels ever since, regardless of the market going up or down. Between 2012 and 2019, the index averaged a figure of about 15. Since the start of COVID-19, it has averaged about 25, or roughly a 65% increase in volatility. We feel this is logical, given we are still struggling to find a new balance, both socially and economically. While we have confidence that we will eventually normalize, the timeline is very hard to estimate because our greatest challenge is the supply chain and people simply need time to solve the associated problems. Until we can see these problems being solved and the rate of inflation declining, we would logically expect markets to remain volatile. 

Market volatility taxes our emotions and tests our conviction. We are accustomed to digesting brief periods of volatility, but we haven’t trained our minds and stomachs for prolonged volatility. So, it is very natural to reflexively conclude that something is different and assume that we need to change our investment behaviors. While it is always possible that the future is different, there is a far greater probability that the future rhymes with the past. When the market is dominated by greed, prices are likely too high. In contrast, when the market is dominated by fear, prices are likely at a discount. In the short term, this basic truth can be the biggest driver of market prices. When we invest in stocks, bonds, mutual funds, and ETFs, we are buying public securities, which means at times they are being valued by collective emotion rather than collective logic. In this regard, we feel we are watching history repeat itself and we are simply in a fear cycle. Our working assumption is that both supply chain challenges and the rate of inflation will improve, which will lead to greater certainty about the future and fear will dissipate. Our opinion is that this is a time for patience.

We believe there may be a substantial cost to reacting emotionally and treating the current environment as something different. It is human nature to succumb to recency bias, in which our minds put more weight on recent events in isolation rather than evaluating them in a historical context. This can cause us to draw incorrect conclusions. For example, between 2007 and 2021, Amazon stock dropped by over 10% on 22 different occasions. Each decline might have caused someone to think differently about the company’s future. However, for those that held the stock continuously during the same 14-year period, they achieved a cumulative return of 8,350%! This is a good example of the benefit of maintaining a long-term view.

We are hearing many people say they want to wait for a clearer picture of the future before they invest or reinvest, which is very understandable. But when the future is again clear, the current discounts will have vanished. Every S&P 500 decline of 15% or more from 1929 to 2020 has been followed by a recovery. The average return in the first year after each of these declines was +55%.

What we are most concerned about is people trying to time the market, as it puts them at risk of missing some of the best days in the market. This might not seem like a big deal, but history tells us it is. $10,000 invested in the S&P 500 at the beginning of 2001 would have grown to $42,231 over 20 years—an average return of +7.47% per year. By missing the 20 best days in the market, that same $10,000 would have only grown to $11,474—an average return of +0.69% per year.

Yes, every market crisis is different from the previous one. Despite their differences, there is commonality. Market downturns of 20% or more have generally happened about once every six years, with the average bear market lasting 14 months. However, the average bull market has lasted 72 months, and more than rewarded those who patiently endured the bear market. We don’t know how long it will take for fear to subside, but we are confident it will, and there is no clear reason to think the realities of our future won’t rhyme with the lessons of the past.

Lastly, and most importantly, all our investment clients have thoughtful, well-diversified strategies that we believe in. It is important to us that you have confidence in your plan. We hope this piece provides some useful perspective. 

To subscribe to the Meritage Periodical, please enter your name and email address below.

Thank you! Oops!