Downturn ahead?

With economic data getting worse and markets looking shaky, the question on everyone’s mind seems to be: our we heading into another economic and market downturn?

Specifically, economic and market data in the U.S. are rolling over, Europe seems to be in full-out recession, and China is growing more slowly with its manufacturing sector even pulling back. This makes everyone wish they knew whether recent trends will continue down, or if a rebound (or central bank support) is on the way.

The reason people care is that it makes a BIG difference on short term returns. If the economy and markets roll over, then you want to be in long bonds, which do great under that scenario. If recent numbers are just a head-fake, and we’re going to see growth resume, you want to own stocks and commodities because they’re dirt cheap assuming growth resumes.

But, the above thinking assumes that it’s possible to know whether the economy and markets will turn down or resume growth. Such an assumption is, however, suspect.

Can experts accurately predict either economic or market downturns? Their track record, contrary to popular belief (and the amount of money you pay for it), is terrible.  

Economists and market strategists, brilliant people who parse economic data on a full-time basis, are dreadful forecasters. As a group, they have never–not once–predicted a recession beforehand. 

Individually, most of them are wrong most of the time. Every once in a while, an economist or market strategist “correctly” predicts a recession or rebound, but no one–and I mean no one–gets it right more than a couple of times. 

Keep in mind that a broken clock is right twice a day–that doesn’t mean it correctly tells time. A market strategist who calls for a downturn all the time will look right one third of the time, and an economist who always calls for growth will be right two thirds of the time. That doesn’t make them accurate forecasters, and that won’t help you get into and out of investments at the right time.

If the experts are consistently wrong, maybe the right place to look is the aggregate opinions of millions of market participants.  Do markets correctly predict market downturns or rebounds?  Not at all.  One famous quote is that “the stock market has predicted 9 of the last 5 recessions.” Translation: markets predict recessions and rebounds much more frequently than they actually occur.  Once again, such guidance does investors more harm than good.

Well, if brilliant experts tracking all the data can’t get it right, and the judgment of crowds can’t do it, what’s to be done?  

First off, accept the premise that, at present, no one has figured out how to consistently time markets over the short term. It’s like forecasting the weather–it’s such a complex and adaptive system that no one knows what’s going to happen ahead of time (even though they can tell you precisely what happened in the past). 

If no one can successfully time the market, then don’t try to do it–don’t try switching in and out of stocks, bond and commodities in a failed attempt to get better returns. Channel Nancy Reagan and just say “no” to market timing.

Instead, do what has worked over the long run: buy cheap and sell dear. Instead of spending gobs of time, effort, and money trying to guess market direction, spend your time trying to figure out which companies to buy and then calculating what price to buy and sell them (relative to underlying fundamentals).

It doesn’t work every time, and it won’t necessarily work over the short term, but it does work over the long term with a high degree of confidence.

Avoid the rat-race of unsuccessfully wondering if a downturn is ahead, and focus instead on underlying value. Your results and your psychological well-being will be better for it.  

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

Downturn ahead?

Prior assumption: saving

As much as I love to blather on about investing in this blog, I must also make clear that all investing rests on a prior assumption: saving.

Put logically, saving precedes investing. Whether you can generate better or worse returns matters little if you don’t save or don’t save enough. A 100% return on $100 dollars will move your retirement meter an immaterial amount more than a 2% return on $100.  

Even prior to saving, you must manage your money. You must earn more than you spend or spend less than you earn to have savings. After that, you need to set aside that money for investment. Only savings can be invested.

My point may seem so blatantly obvious that it goes without saying. But, the truth is, people focus too much on investing (including yours truly) and not enough on saving.

There are two additional points with respect to saving that should be highlighted: 1) the more you save, the better; and 2) the earlier you save, the better.

To elaborate on #1, even if you generate moderate or weak returns, you can reach your goals if you save enough. For example, someone who saves $2,260 a year and generates 10% annual returns from the time they are 25 to 65 will have just as much money as someone who saves $8,278 a year and gets 5% returns from 25 to 65. 

Yes, the second person must save much more than the first, but savings can make up for poor returns. It’s smarter to adjust your savings to the returns you get rather than vice versa.

Also, the impact of compounding is greatly enhanced by saving more over time.  Even if you don’t get great returns, you can always work hard to save more money (earn more, spend less). The more you save, the better the outcome, all things equal.

The second point is probably even more important: the earlier you save, the better.

Early savings benefit more from compounding than later savings. For instance, if you assume two people get 10% returns, someone who saves $1,000 a year from age 25 to 35, but then doesn’t save another dollar, will end up with $278,100 by age 65; whereas someone who saves $1,000 a year from 35 to 65 will end up with $164,500. Even though the first person saved only $10,000 and the second saved $30,000–three times as much–the fact that the first person started earlier means they end up with 70% more money and therefore a 70% higher standard of living.

Many people think such an argument is pointless if you aren’t 25, but the math is the same with 40 to 50 and 50 to 80, or 55 to 65 and 65 to 95. The earlier you save, the better.

The prior assumption of saving before investment is frequently overlooked, but need not be.  

  • Saving precedes investment
  • Raise your savings to meet future goals
  • Start investing earlier rather than later 

Getting great returns is only relevant once you’ve saved enough–so focus on saving first.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

Prior assumption: saving

Patient capital

People are generally too impatient. Unfortunately, this doesn’t serve them well.

Whether chasing crash diets, miracle cures, or playing the lottery, most people want quick fixes. They understand that longer term paths to success–eating less and exercising more–work, but they aren’t willing to put in the time and effort to succeed. They want results NOW, so they end up with results alright–bad results!

One reason people do this is they get fooled by randomness (to use Nassim Taleb’s phraseology). Short term solutions sometimes appear to work, and long term solutions sometimes appear not to work. Luck and timing plays a much bigger role in the short run, and this throws people off. If they were more patient, they’d figure out what works over the long run and stick with that instead of chasing quick fixes.

This phenomenon is readily on display with investing. Value investing–making investments with low price to fundamentals (sales, assets, earnings, book value, etc.)–consistently beats growth investing–high price to fundamentals–over the long run. But, randomness leads growth to sometimes out-perform value for a period, which leads impatient investors to chase what is “working” in the short run. They begin their chase only to find value out-performing growth yet again.

Why not just be a value investor through thick and thin? Because it requires a lot of patience.  

Just like people jump into fad diets, they won’t stick to value investing because it isn’t “working” right NOW. After all, it’s hard to stick with something that isn’t working, especially because this under-performance can go on for years (the last 7 being a good, but not historically unusual, example).  

But, just as night follows day, value investing will win over time, and patient investors will be the one’s retiring on time while their impatient brethren are putting off retirement for a few more years.

Such is life.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

Patient capital

Unsurprising drop

The stock market was down 2.5% on its first trading day of June. This follows a decline of 6.8% in May, leaving stocks down 10.2% since its high of April this year, and down 18.9% since the high of October 2007. This seems to have surprised, and even shocked, many investors.

When asked what the stock market would do, J.P. Morgan famously said, “It will fluctuate.” Benjamin Graham told investors (in his book The Intelligent Investor) to resign themselves in advance “to the probability rather than the mere possibility that most of his holdings will advance, say, 50% or more from their low point and decline the equivalent of one-third or more from their high point at various periods.”

In other words, the stock market is a roller coaster, and investors should anticipate and even expect frequent stomach-churning drops and thrilling climbs along the way. These drops are not a sign of something unusual and dreaded, but something expected and even eagerly anticipated. Why? Because drops lead to opportunity as merchandise that cost $100 a few days ago is now on sale for less (sometimes, much less).

As I pointed out in my posts, Better than zero and “Where’s the market going next year?”, the math underlying expected future returns should have warned investors to anticipate drops. And, as I expressed in my post, All eyes on China, news of slowing growth from China would likely lead markets lower, and it has.

I think investors were surprised because they don’t think of the stock market as a roller coaster, or they try too hard to relish the climbs and forget the inevitable drops. Perhaps they also suffer from myopia, attending to recent company reports and economic news instead of thinking about longer term data. 

Nevertheless, drops will happen, and they should be exploited instead of feared. Lower prices mean higher future returns–clearly a good thing. Panicky investors that sell as the market drops benefit longer term investors that buy from them. I’m not saying the drops won’t pull at your stomach–they will. What I’m saying is drops are to be expected and wise investors will have the courage to act as the market drops to exploit short-term oriented investors.

I’m not panicking as my portfolio drops, but lining up my buy list and making purchases as the market sinks. The more it sinks, the more I’ll buy. Just like riding a roller coaster, I look forward to the plunges and climbs, because that’s the nature of the beast.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

Unsurprising drop