Ah…so that’s what risk feels like

Global markets have been thumped pretty bad over the last week, and the last two trading days in particular. As of the time of this writing (Tuesday morning, 4:30am), it appears today will open lower as well. Will that hold? I don’t know. It depends on whether traders buy more than they sell today.

Yesterday, the Dow lost more points than any single day in history. This statement, of course, is the headline story for several news outlets. However, in percentage terms, it only marks the 108th worst day in its 121-year history.

Make no mistake, the market fell sharply, but it was far from its worst day ever. Further, the last time we experienced a drop like this was 2011, so it has been about seven years since we felt this roughly once-per-year event.

We wrote and talked with you at length over the last year about how strange of a year it was, where volatility basically evaporated from the global markets. Stocks seemed to be riding a wave of positive economic news toward an endless horizon.

Corrections are a great reminder that when it comes to investing, we must engage markets with a heavy dose of humility, patience and respect for what markets can and can’t do. As soon as we think we have them figured out, we run headfirst into a wall. People prepare for risk events based on what they anticipate or see coming. But the reality is that risk is what you can’t see coming. Market corrections often seem to come out of nowhere, and they hit us fast and furious.

We have all been “waiting” for the market to correct. The majority of you have even offered that suggestion yourselves. Yet even as we were anticipating this to happen, portfolios have earned a very healthy sum of gains. In virtually every conversation we have been having with clients, we have been reminding you that this seemingly endless party will not last forever, but it can last a lot longer than we expect.

However, in recent weeks, we seemed to be talking more people off the proverbial ledge. This time around, instead of having to stop people from jumping out as the market drops, we were holding people back from increasing their stock allocations as markets rose. These conversations make me the most nervous.

It is a testament to you, as clients, that the bulk of our investment-related conversations over the last year or so have been the right ones. You are asking far more about risk exposures, whether portfolios have reached levels where we can reduce your stock allocation and still meet your long-term objectives, etc. Very few of you have been asking for more risk, or more stocks, and are instead concerned about being appropriately positioned for inevitable events such as the market drop this past week.

On the contrary, as the market has been rising, the general population wishes they had a riskier portfolio – a higher stock allocation. In addition, they tend to look at the relatively miniscule returns they are earning in bonds, and fear that they are missing out. We have to look no further than observing fund flows to see that people tirelessly chase returns.

And it isn’t just people. The majority of trading in the modern financial markets is driven by computers and algorithms. Yesterday’s trading was overwhelmingly driven by machines. Many are programmed for momentum trends, where they will sell more when markets are falling and buy more when markets are rising.

We have said it before and we will continue to say it again. You can’t buy last year’s returns. That goes for stocks, bonds, real estate, or bitcoin. What happened in the past is over, and as solid as a trend may appear, recognize that the fear of missing out is clouding your judgment. Everything appears obvious in hindsight. The future is unforgiving.

At the end of the day, markets fall because there are more sellers than buyers. We have had a lot of buyers over the last year, with people piling-in to try to make-up for years of sitting on the sidelines as markets rose.

Admittedly, over the last several weeks, we have been overwhelmingly net sellers. This is not a market timing exercise, but a simple act of rebalancing client portfolios. When markets skyrocket, our stock allocations get too high, so we sell some of those gains and buy bonds. Similarly, for those on periodic investment plans, if your stock allocation is high, we do not just pile into stocks. Instead, we use those ongoing contributions to buy bonds and keep the risk profile in-tact.

Resist the urge to try to seek out THE reason the markets dropped so sharply in recent days. There are a lot of reasons this happens, as there are tens of thousands of factors that impact economies, traders, political, tax and monetary policy, as well as long-term investment decisions. Trying to pinpoint the cause is a recipe for driving yourself crazy and making bad decisions.

Market corrections never feel good, but I will offer that they are actually quite healthy. People have been starting to act as if there is no risk in markets anymore. Stock prices in certain areas of the market have been driven up to unsustainable levels, and we are seeing utter nonsense as the stock of companies like Kodak (yes, the camera company) quadrupled almost overnight at the mere mention they are thinking of launching a cryptocurrency. Not surprisingly, most of those gains have already been given back.

Further, in a move nearly identical to the dot com craze in the late 90’s, other companies are changing their name to somehow reference blockchain or e-coin offerings, and their stock prices immediately (temporarily) soar. People are even refinancing houses to invest in cryptocurrencies.

This stuff is not healthy in a functioning market. Fortunately, given some time, the market is very efficient at flushing this stuff out. As Warren Buffett states, “the stock market is a device for transferring wealth from the impatient to the patient.” All those looking to make a quick buck through these desperate acts are in for a rude awakening.

Let the impatient be impatient. Those who remain disciplined and patient have been rewarded over the long term time and time again.

Also, let this serve as another important reminder that the stock market is not the economy, and the economy is not the stock market. The undertones of our economy are strong, and our companies are performing well. However, the market already knows this, and that information has already been acted upon. Corrections can happen when market participants overdo it. They are just working to get it right.

Be careful about overconfidence and your influence on performance. Investors routinely take credit for gains, yet blame others for losses. We are very limited in what we can control in markets, and markets couldn’t care less about our feelings, desires, or actions.

There were a lot of jokes being made yesterday about the split screen coverage of President Trump touting the strength of the economy on one side, as the market plummeted on the other. Trump is not the first president trying to take credit for market performance, and he certainly won’t be the last. However, the lack of humility created a very embarrassing moment. This serves as yet another reminder that the market really doesn’t care who you are or what you are trying to convey.

This is not our first rodeo, and we have weathered many of these seas over the years. Rest assured, our focus is not on trying to outsmart the algorithms and machines, but to play a different game. We are razor focused on your risk profiles, stock-to-bond allocations, and we will be ready with an eager trigger to rebalance again the other direction (bonds to stocks) if the markets keep dropping.

Finally, with yesterday’s decline, the YTD performance of the Dow fell all the way to -0.4%. You are ok. You have a world-class investment strategy in place to ensure that you make smart decisions through tough periods in time. Your philosophy is time-tested, evidence-based, and is the culmination of a lifetime of collaborative work from several Nobel Laureates.

Best of all, the allocation you have today is specifically designed to meet the needs of your situation. You have enough risk to meet your long-term objectives, but no more than is needed to do so. Your portfolio will inevitably experience some downturns over your lifetime, but with patience and discipline, it will prevail.