It’s been just over 3 years since the March, 2009
market bottom of 666 on the S&P 500 index, following the financial crisis
of ’08-’09 and the ensuing ‘Great Recession’. In that time, the market has
rebounded over 100%, despite a lackluster recovery in jobs, exploding budget
deficits and multiple political and financial flare-ups around the globe. And
as we enter the summer season amid the latest crises du jour, and the
inevitable doomsday commentary that accompanies them, it feels, as the great
Yogi Berra so eloquently put it, like déjà vu all over again.
It was only last summer that we were embroiled in a
crippling European debt crisis, a deadly debt ceiling debate and a slowing
economic recovery that was in danger of slipping back into recession. We can’t
help but think of the catastrophic nature of the headlines that were coming
across our screens at the time and how similar they were to the ones we have
been seeing lately. To be sure, there are serious problems in Europe, and the
fiscal cliff here in the U.S. is an issue that will need to be dealt with, but
are any of these problems more severe than those that existed last year or 10,
20 even 50 years ago?
It comes as no surprise that the commentary is so melodramatic.
After all, sensationalism is nothing new, especially when it comes to financial
news reporting. However, the sheer
volume of reporting that is available to the average investor on a day-to-day
basis now is staggering. Being plugged in as we are to our computers, phones,
tablets and even the old standby, T.V. (remember that?); via Twitter, Facebook,
Youtube, RSS Feeds and the like, media outlets and pundits have limitless
opportunity to proffer their dire messages. As a result, a person can easily
see a headline like “Eurozone in Crisis” or “Growth to Stall as Fiscal Cliff
Looms” 10 to 15 times or more in a single day. When you compare that to, say,
30 years ago, where a person might read
a story or two in the morning paper on one of those topics, perhaps followed by
a piece on the evening news, we’re left wondering what the effect is on the
average investor of all the additional exposure to so called “news”. It is also
worth noting that the concept of “consider the source” has become so much more critical
in this environment since the article or headline you’re seeing may have been
posted and reposted or tweeted and re-tweeted many times over before landing on
your screen.
For years we have read about and talked with clients
about the underperformance of average investor returns versus the overall
markets, and the most recent Dalbar study outlines this point once again. For
the twenty years ending 12/31/2011 the S&P 500 Index averaged 7.81% a year,
but the average equity fund investor earned a market return of only 3.49%
(Dalbar Inc. 2012 Quantitative Analysis of Investor Behavior). This is the same
20 year period that included the bursting of the dot com bubble as well as the
so called ‘Great Recession’. The root causes of such underperformance are many,
and we are reluctant to pin all of the blame on the media, but there is no
doubt, in our minds at least, that the constant negative discourse plays a
significant role. It is clear from these numbers that investor behavior is the
main driver of investor results, and the combination of negative commentary,
past volatility and loss aversion can cause calamitous outcomes. In prospect
theory, loss aversion refers to the tendency for people to strongly prefer
avoiding losses to acquiring gains. Some studies suggest that losses are as
much as twice as psychologically powerful as gains.
It is this
emotional bias that, when coupled with the onslaught of negative media
commentary, is what we believe leads people to the four most dangerous words in
the investor’s vocabulary: “It’s different this time”. What is so dangerous
about those words is that in the short run, things are different. That is, the
circumstances that exist and work together to cause a bear market or recession are different each time. Unfortunately,
that only gives credence to the panic-driven investor who is prone to
liquidating at the bottom. One can always find some condition in the markets or
broader world that didn’t exactly exist at any other point in time, and likely
a headline (or many headlines) to suggest that its existence will cause
gruesome results the likes of which have never been seen before. But the truth,
so well put by financial writer/advisor Nick Murray, is that “…in the long run,
the market cycle is never different; it is an irregular pattern of excessive
optimism followed by excessive pessimism and back again, cycling around a
secularly rising trendline.” In that
context, the idea that it is different this time can become the rationale for
poor, emotionally-driven investment decisions, the most likely outcome of which
is vast underperformance compared to the overall markets, and the erosion of
purchasing power over time.
What the most successful investors are able to do
(think Warren Buffet) is block out the constant noise of those selling
newspapers, ad time or their new ‘investment idea’ and think long-term, even
generationally. While the market’s movements are extraordinarily difficult
(some would say impossible) to predict in the short to medium term, they have
historically been quite easy to gauge when you start looking at 20-, 30-, and
40-year rolling periods. When seen from
that perspective, downturns appear as buying opportunities, up-markets as a
time to take profits; the whole as a systematic, even methodical cycle of up
and down with an ever increasing base from which to operate. It is this
perspective that, above all, provides the basis for sound financial advice.
So, as we see another summer slowly slip away, and
prepare to enter a fall season full of uncertainty (who will win the election,
will the Europeans fix their fiscal woes, will congress finally get together?),
our advice remains the same as ever. Have a plan, stick to it through up and
down, make sure to enjoy some quality time with friends and loved ones and try
to avoid the hand-wringing over the latest headlines. Because, as with the
weather, eventually, the issues we face will change, today’s questions will be answered
and replaced with new ones, and most important, it’s not different this time.
_______________________________
The opinions voiced in this material are for general information only and
are not intended to provide specific advice or recommendations for any
individual. To determine which investment(s) may be appropriate for you,
consult your financial advisor prior to investing.
Dalbar’s 2012 Quantitative Analysis of Investor Behavior (QAIB) study
examines real investor returns from equity, fixed income and money market
mutual funds from January 1984 through December 2011. The study was originally
conducted by Dalbar, Inc in 1994 a d was the first to investigate how mutual
fund investors’ behavior affects the returns they actually earn.
Past performance is no guarantee of future results. Indexes cannot be
invested into directly.
Nick Murray is not affiliated nor endorsed by LPL Financial or Topel &
DiStasi Wealth Management.
