Published April 26, 2019
As much as commentators try to explain stock price fluctuations in terms of economics, earnings, and other fundamental drivers, there is an equal helping of pure human emotion involved – the “fear and greed” factor. Our investment models remove the emotion as we feel that the emotion works against us. Humans are built to dwell on their losses in order to protect themselves from future harm. While we certainly celebrate our successes, studies show that our successes have a relatively minor impact on our long-term behavior, when compared to the fear/protect response. In other words, we magnify our losses and minimize our successes, emotionally. When looked at on an annual return basis, the stock market delivers joy, happiness, and positive returns over 70% of the time. Even when the stock market returns a loss in a given year, that loss is 10% or less over half the time. In short, your odds of encountering a loss greater than -10% in your portfolio in a given year is only 12%, or just over once a decade.
That seems like a compelling argument for buy-and-hold investing, doesn’t it? Nine years of happy returns and only one setback, that loss being quite a bit less than the nine years of gains – usually. The problem is the human emotion aspect. The stock market swings widely within the year and, in some periods, from one year to the next. For example, in the volatile markets of the 1930s and 1940s, we had an equal number of winning and losing years. Three of those years were losses of over -20%. It’s hard to be an investor when you feel like you have a reasonable chance of losing -20% or more every year. The vast majority of people react to that level of pain by selling everything and taking cover in cash, forsaking the stock market forever more. Imagine the emotional roller-coaster of these two decades of investing. The histogram below shows the period from 1929-1937 in yellow – a period of dramatic annual gains and losses. The green boxes show the subsequent decade. It’s relatively positive, though still marked by losses in almost half the years. Losing years were commonplace with +/-20% years fully half the time.
By contrast, the past decade has been unusually benign. The 2000s were painful, with four of ten losing years (and the decade overall famously posting zero return). Two of those losing years (2002 and 2008) were quite significant and shocking, coming after the rip-roaring 1990s. However, investors have been rewarded with a period of unusual stability, only a single losing year in the past ten (same as the 1990s it turns out).
Across the two decades (2000s and 2010s), the results are typical though, with annual losses about one every four years. As we approach a new decade of the 2020s, having just concluded a very investor-friendly period of years post-2008, will stocks return to form posting annual losses on fairly regular basis and rewarding investors who take a nimble approach rather than buying and holding? Will there be one or more years that significantly try investor nerves?
It’s no surprise that in this period with few losing years passive buy-and-hold investing has become quite attractive. It will also be no surprise if the coming decade reminds investors that buying and holding takes a great deal of emotional fortitude; and that being a bit more active, with a good, disciplined system of entry and exit, has its benefits.
Stocks opened the week flat with energy stocks leading as oil prices rose when the U.S. reimposed sanctions on Iranian oil supplies. Tuesday saw a broad-based rally with stocks rising +0.9% on strong earnings from a wide range of companies such as United Technologies (UTX), Coca-Cola (KO), Twitter (TWTR), and Lockheed-Martin (LMT). Stocks were unable to follow through, however, Wednesday as indexes dipped -0.2%. Weak results from Caterpillar (CAT) reminded investors of the dicey global economic picture. Those concerns were echoed again Thursday as 3M (MMM) also disappointed investors amid a cautious outlook. Strong results from Microsoft (MSFT) provided an offsetting positive to keep the broad market flat on the day. Friday also brought a mixed bag, though stocks managed to close with solid +0.5% gains on the day. Strong results from Amazon (AMZN) and a +3% GDP report for the first quarter underscored the solid domestic economic picture. Weakness in semiconductors and energy, after reports from Intel (INTC) and energy giants Exxon (XOM) and Chevron (CVX), held the market back.
The S&P 500 (SPY) pushed further above the 2900 level this week, gaining +1.17%. The Nasdaq 100 (QQQ) posted record highs on a +1.74% weekly rise. The QQQ has posted gains in 16 of the past 18 weeks, with one of those losing weeks being essentially flat. It’s an extraordinary run for the index. Small-caps (IWM) added +1.69% but remain well below their highs. Interest rates resumed their downward push, an oddity in a strong stock market, as declining rates usually reflect economic concerns.
Warm wishes and until next week.