by Andrew Murphy, CFA Director of Portfolio Management We’ve received a few questions over the…
June 2020 Client Question: Dire Market PredictionsClient Question of the Month |
by Andrew Murphy, CFA | Senior Director of Portfolio Management
As a wealth management firm we are inundated with a never ending flow of predictions about what is going to happen in the markets. Just last week we received a letter from a firm who claimed they could “mathematically predict the stock market, in both price and time, with astonishing accuracy” (spoiler alert: they can’t). We also understand that our clients are not isolated from the constant barrage of news, noise, and prognostications. We often have conversations with our clients regarding a so-called expert’s prediction on an upcoming market crash. In today’s 24-hour news environment, with several financial television stations, radio networks, and countless publications, there is always someone willing to offer a gloom-and-doom outlook. Keep in mind that the media outlets are not paid to provide sound financial advice and negativity sells. Also remember that market risks are constant and that volatility can create opportunities. The key to successful long-term investing is managing risk by identifying and reacting to those that matter and not overreacting to those that do not.
Given the market volatility over the last several weeks, dismal market forecasters have been everywhere. Every time the market experiences a pullback there is a rush from certain market participants to proclaim that the drop is the start of the next great bear market (some of these experts have been predicting the same thing for years and even decades). We constantly remind our clients to maintain a long-term viewpoint as markets can be extremely volatile in the short term. Since 1928 the S&P 500 has generated a total annualized of return of +9.5% despite averaging a decline of nearly -16% at some point each year. As stock market investors, volatility and declines are the prices we pay for excess return over the risk-free rate. The risk-free interest rate is defined as the return of an investment with no risk of financial loss. US Treasury Bills are typically used as the risk-free rate as their principal repayments are backed by the US government. Would an investor put their money in stocks if they could produce a similar return by investing in Treasury Bills? No, they wouldn’t. Investors need to be compensated for the greater risk of investing in stocks over Treasury Bills. Over the last sixty years the S&P 500 has averaged an excess return over Treasuries of about 7% per year. Investors who understand the trade-off between risk and return will generate better long-term results than someone who panics at the first sign of inevitable volatility. Please see our Winthrop Wealth Principles for Investing in the Stock Market.
One of our favorite research pieces in recent months is called “The Armageddonists” from JP Morgan Asset Management. Armageddonists are defined as the “market-watchers, forecasters, and money managers whose apocalyptic comments spread like wildfire in print and online financial news.” Over the period 2010-2019, JP Morgan collected predictions of market crashes and recessions from several notable investors and then calculated the result if an investor followed those predictions. This analysis was done before the covid-19 bear market that occurred earlier this year. In the future, there could easily be an update of this report with some of the recent grim forecasts.
The last decade was especially strong for the US equity market as the S&P 500 produced a total return of +256.4% (annualized return of +13.5% per year). An investment of $10,000 beginning in 2010 would have grown to $35,600. *See below for several dire market predictions during this period.
The following chart displays the opportunity cost of following those predictions, and assumes an investor switched their portfolio from 100% stocks to 100% bonds. Given the substantial return in the equity market over the last decade, an investor would have shot themselves in foot by listening to the Armageddonists and selling all of their stocks. We know that making sudden large adjustments to client portfolios is value destructive over time, and one of the key tenants of our investment philosophy is to never time the market. You can find our thoughts on market timing and the crushing impact it has on investor returns here.
1 Cembalest, M. (2019). Eye on the Market: The Armageddonists. JP Morgan Asset Management
We know that the United States is currently in a recession and suffered its first bear market in over a decade when the S&P 500 fell by nearly -34% from February 19th to March 23rd. However, the recent dismal predictions only worked for a short amount of time as the market rebounded by over +36% from March 23rd to the end of May. A taxable investor who sold their securities in February or March likely would have generated large capital gains and then missed the subsequent rebound. Given that the stock market rises over time and declines don’t last forever (bull markets have historically lasted longer than bear markets), we suspect that in the future there will be more bad market predictions than good ones. We typically offer the following advice in response to a dreadful market forecast:
- Be a little bit skeptical: an extreme market prediction like an upcoming crash or severe recession can often be designed to draw attention to the person making the forecast and/or their firm. The bold prediction is designed to sell you something and really boils down to, “the market might go down and the best thing you can do is buy my product.” The person making the prediction often has an agenda and is looking to further their own self interest.
- Be aware of moving goalposts: We often see the initial prediction but miss the follow up later that completely negates the original. Predictions constantly change. The investment phrase, “if you must forecast, forecast often” exists for a reason.
- Understand the person and the data: Anyone can make a bold market prediction. Consider the qualifications of the person, the data behind the prediction, and their past track record before considering to take action.
At Winthrop Wealth, we apply a total net worth approach to both comprehensive financial planning and investment management. Financial planning drives the investment strategy and provides a road-map to each client’s unique goals and objectives. The comprehensive financial plan defines cash flow needs, is stress tested for various market environments, optimizes account structures, considers tax minimization strategies, and continuously evaluates financial risks as circumstances and/or goals change. The investment management process is designed to provide well-diversified portfolios constructed with a methodology based on prudent risk management, asset allocation, and security selection.
As always, please contact us if you have any questions or updates to your personal or financial circumstances.
The economic forecasts set forth in this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful.
Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual.
All indexes mentioned are unmanaged indexes which cannot be invested into directly. Unmanaged index returns do not reflect fees, expenses, or sales charges. Index performance is not indicative of the performance of any investment. Past performance is no guarantee of future results.
The Standard & Poor’s 500 Index is a capitalization weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.
The Bloomberg Barclays U.S. Aggregate Bond Index is an index of the U.S. investment-grade fixed-rate bond market, including both government and corporate bonds.
Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise and bonds are subject to availability and change
Financial planning is a tool intended to review your current financial situation, investment objectives and goals, and suggest potential planning ideas and concepts that may be of benefit. There is no guarantee that financial planning will help you reach your goals.
Likewise, it is important to remember that no investment strategy assures success or protects against loss. Asset allocation does not ensure a profit or protect against loss. There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio.
Diversification does not protect against market risk. Rebalancing a portfolio may cause you to incur tax liabilities and/or transaction costs and does not assure a profit or protect against a loss. All investing involves risk which you should be prepared to bear.