On December 24th, the S&P 500 closed at 2,351. From a high in late September of 2,930, the index had declined nearly 20%. What was shaping up to be another strong year a few months earlier now looked like it would end with a decline of more than 10% for the index. In addition, between talk of trade wars and weakening economic data, the risk of further losses seemed heightened. If we imagine ourselves back in December, here’s what you would’ve read if you picked up a newspaper like USA Today (edited for brevity):
The stock market entered the holidays on a grim note, with the Standard & Poor's 500 stopping short of bear market territory and on track for its worst December since 1931.
The plunge on a shortened trading day came as President Trump doubled down on his criticisms of the Federal Reserve and after attempts by the U.S. Treasury secretary to reassure markets unsettled investors instead.
The Standard & Poor's 500 lost 66 points, or 2.7%, to close out Monday at 2,351. The Dow Jones Industrial average dropped 653 points, or 2.9%, to end at 21,792. The tech-heavy Nasdaq, which fell into official bear territory on Friday, lost 140 points, or 2.2%, to finish at 6,193. The Russell 2000, an index of small-company stocks that's also in a bear market, ended down 2.0%, at 1,267.
"There’s a lot of political unrest," said Jimmy Lee, CEO of the Wealth Consulting Group. "And when you have uncertainty and a lack of confidence in leadership, it makes investors nervous and it has. They run to safety."
The moves come after Trump reportedly discussed firing Federal Reserve Chairman Jerome Powell, blaming the recent turmoil in the stock market on the central bank's Wednesday hike of a benchmark interest rate and its rate outlook for next year.
On Sunday, Treasury Secretary Steve Mnuchin announced that he had called the chief executives of the six biggest U.S. banks to ensure they had enough liquidity to operate normally. The unexpected move rattled investors.
Also adding to the political chaos was Trump's removal of Defense Secretary James Mattis before the general's planned departure, along with the continuing partial shutdown of the federal government.
There’s not much there to inspire confidence. In addition, with endless talk in the financial press over the preceding quarters about the longest running bull market in history, it was only natural for people to wonder when the party would come to its inevitable end. The average individual might have taken this confluence of factors as a sign that they should reduce the amount of equity exposure in their portfolio – or even get out of the market entirely.
But what has happened since shows just how dangerous this thought process can be. In the last week of 2018, the S&P 500 climbed by roughly 7%. In the first quarter of 2019, the total return for the S&P 500 was another gain of roughly 14% - the best quarter for the S&P 500 in a decade. As of Tuesday’s close, the S&P 500 is only 2% lower than the highs reached in late September. In total, it has returned 22% since Christmas Eve. Individuals that cut their equity allocations in December based on recent market volatility or due to concerns about macroeconomic and political developments have paid a steep price for doing so.
In addition, they’re left in a precarious position. Most of the concerns mentioned in the USA Today article (or the endless number of articles just like it at that time) either remain with us or have been replaced by other issues (that’s not surprising – the future is always uncertain, and there are always risks to consider). Now these individuals have to answer a very difficult question: What should I do now? Do they capitulate and repurchase the stocks they sold a few months ago at prices that are 20% higher, or do they want for something else to happen before they get back in?
I can feel for them: If I was in their position, I would have no idea how to intelligently answer that question. It's for that reason that I decided a long time ago that I have no interest in playing that game. I mostly came to that conclusion by listening to investors who are a lot smarter and more experienced than I am. As I've built up my own experience in this business, I’ve also seen how the market timing strategy has worked for these individuals in real time. Here's what I've concluded so far: Over the past ten-plus years, I’ve seen an endless list of people try to jump in and out of the market – and as far as I can tell, none of them are better off for having done so.
To be clear, this isn’t a call to own stocks at any price. It’s also not a suggestion for you to invest with your eyes closed. Instead, it’s an endorsement for an asset allocation that focuses on an appropriate mix of stocks and bonds based on your willingness and ability to bear risk – and to largely stick with that allocation over time. In my view, there is almost no scenario where an individual should make huge changes to an appropriate allocation. If the “right” mix for you is 60% stocks and 40% bonds, you should try to stay near that target throughout the market cycle. A corollary to that is if a 60% stock allocation is too much to handle during bouts of market volatility, the answer isn’t to try and get ahead of downturns --it’s to allocate much less than 60% of your portfolio to stocks (the simple truth is that some people do not have the temperament to live through the inevitable bouts of volatility they will face if they invest for long enough). Those that failed to adhere to those simple principles at the end of 2018 have learned an expensive lesson.
What’s in store for us over the remainder of 2019 is anybody’s guess.I think anybody who is focusing their attention on trying to predict what will happen in the coming months is playing the wrong game - or at least a game they’re much less likely to win at long term than the alternative.
Disclosure: None.
