In the next day or so, you should be receiving your end-of-June LPL statements. Although the statements will sport a new, improved format, for most clients, these will be the most disappointing statements in some time. As you may know, June was an ugly month across the board in global equity markets. Almost every broad equity category was down between 8% and 11% in June alone – and this on top of what had already been a tough and trying eight months since early October, when the recent slide began. Making the market’s performance even more unbearable, no doubt, is the endless streaming of a 24-hour cycle of bad news on the cable network of your choosing. (Is there really any other kind of news on television?)
In no particular order, here are a few points I’d like you to keep in mind as you open your June statements:
Oil Prices
Let’s start with the price of oil, which of course is at an all time high, partly due to concerns about worldwide supply-and-demand imbalances, partly due to political issues, and partly due, of course, to the falling dollar. (By some economists’ estimates, more than $25 per barrel of the current price increase is due to the declining value of the US dollar.) While there are, no doubt, legitimate concerns on all of these fronts, much of the price increase looks to me like a bubble, not unlike the then-record oil price bubble of the late ’70s / early 80’s.
In late 1979, oil peaked at $106 (in inflation-adjusted April 2008 dollars) after a seven-year rise and then shortly thereafter began its equally spectacular 81% decline from 1980 to 1986, eventually falling to $20 / barrel (again, in April 2008 dollars). The concern, of course, is that “this time it’s different”, but, then again, isn’t that always the essential concern of every catastrophe du jour?
For those who have forgotten the bubbles of yesteryear and who are worried that this time really is different, here’s a hit parade of other really spectacular bubbles, some recent, some not, all of which eventually popped, as bubbles seem to always do, despite endless choruses of “this time it really is different.”
- the great TulipMania of Amsterdam (1637);
- South Sea Company bubble (1720), in which Sir Isaac Newton (yes, that Isaac Newton) lost a considerable fortune, £20,000 sterling – millions and millions in today’s dollars;
- the US “Nifty Fifty” stock market bubble (late 1960’s / early 1970’s);
- the Gold bubble of the late ’70s (1977 – 1980);
- the Japanese asset bubble (lasted for most of the 1980s, and covered pretty much anything that was Japanese);
- the DotCom Technology bubble (1995 – 2001), and of course;
- the US Housing Market Bubble (2001 – 2005) – especially in once hot markets like Florida and Arizona.
Could it really be different this time? Well, possibly, but that might be a first. So, while we may not see $20 / barrel oil again, I personally would be surprised in the long term to see $145 as a new permanent high (although I’ll be the first to admit it could get worse before it gets better).
(Also, for anyone environmentally concerned, they might consider rejoicing. While painful at the pump, high prices, over time, do tend to stimulate investments in energy conservation, more efficient technologies, alternative fuel sources, and smaller vehicles, so if you’re environmentally conscious and looking for a silver lining . . . )
Market Performance & A Little History (Again)
As of this writing, the two major US Market indexes (the Dow Jones Industrial Average and the S&P 500) are both down about 20% from their October highs. While seemingly tragic, it’s worth keeping in mind that the US markets have historically dropped between 20% and 40% about once ever five years since 1900. So, while “this time” feels like the end of the world – and the media, of course, insisting that it is – it’s probably not. Also, keep in mind, that anyone with a portfolio that includes a fixed income and/or cash component is probably not experiencing the full brunt of the US market’s decline.
It’s also worth keeping in mind that price and value are inversely correlated (i.e., Price = 1 / Value). This means that the lower the price, the greater the value; the higher the price, the lower the value. So, the lower the current markets are priced, all other things being equal, the greater the inherent value, and arguably, the lesser the overall risk moving forward. Looking at it another way, and as I said in a previous writing, the further things go down, the less likely they are to go down even further.
As I also pointed out in my last missive, the period from 1972 through 1982 was a “lost decade” for holders of only the US markets. The net return of being only in the US large cap market was close to zero for that decade, but for the holder of a globally diversified portfolio[1] , the returns were quite positive. While the US market has done better than zero over the last 10 years, it hasn’t been impressive; the results for that globally diversified portfolio, however, have been much better. Despite the June statement that you’re about to receive and despite relatively modest US equity market performance thus far this decade, try to remember that there are other asset classes that make up a well-diversified portfolio and try to remember that, historically, time has tended to heal the market’s wounds for a globally well-diversified investor.
If you’d like to read my previous article which discusses returns for a globally diversified equity portfolio during the period from 1973 to 1982, despite an abysmal 1973-1974, click on the following link:
Haven’t We Seen This Movie Before?
Psychological Factors Affecting Our Decision-making
There’s more than an abundance of evidence that clearly shows, as humans, we are not well equipped for complex financial decision-making – especially under emotional circumstances. In 2002, Princeton psychologist Daniel Kanheman won the Nobel Prize in economics for his work on behavioral finance, which I’ve written about before. The crux of this research, which may seem like a blinding flash of the obvious, is that we – imperfect creatures that we are – are not perfectly rational decision-makers. (It only took me a year in this business to actually figure that out for myself.)
Two of the more relevant findings of this research are that people systematically exhibit a recency bias and an availability bias. The recency bias essentially says that we tend to – often incorrectly – assign more weight in our decision-making to a recent event than to one than occurred longer ago. There’s no reason that we should, and in many cases, the events that occurred years ago should carry more weight than the more recent events of yesterday, but none-the-less, we often assign a disproportionate weight to the more recent events. A very good example of this would be paying too much attention to this month’s investment performance and not enough attention to the many such periods in the past that were eventually followed by strong market recoveries.
The availability bias points out that we (again often inappropriately) tend to assign more weight to those activities that we can easily access in our memories (a vivid plane crash story we saw on CNN several years ago) than to those we can access with less ease (the 43,000 nameless people who die in the US every year in auto accidents). This would explain why so many are afraid to fly, even though the odds of dying in an auto accident are 1000 times greater.
These two biases help explain why it’s so easy to panic and sell-out at or near a market bottom, when any reasonable survey of history would indicate that that’s the last thing we should do.
So, What Can You / Should You Do?
First of all, stop watching the news. There is very little actionable information you’ll find on CNN / MS-NBC / CNBC / FOX. I know for some, this is like saying, “just give up the crack”, but it’s probably one of the single best things one can do in an environment like this. As an aside, I turned on the NBC Evening News last night – by mistake – and watched 22 minutes of the California wildfire, how rising gas prices are altering US lifestyles, G-8 leaders confronting climate change, and residents of a Midwest town surveying the damage of the recent floods. I think there was also a story about GM possibly laying off thousands and, of course, the stock market’s decline from the Friday before. Nothing here that in any way, shape or form tells me 1) what I should do about my future or 2) what I should do about yours – and not to mention depressing. This is just not helpful. If you have to get news, you’d probably do better and be able to be more selective with “print” (or the online equivalent).
(By the way, in case you’re wondering, personally I do closely follow the market and economic news because it’s my job to do so – not necessarily because it’s terribly helpful in making appropriate long-term decisions, but I do steel myself with a more-than-offsetting amount of long-term market history, which helps keep the day-to-day and month-to-month doom-and-gloom in, what I think is, its proper perspective.)
Secondly, if I may so suggest, read something – anything – historical in nature. I’m currently in the middle of “To Conquer the Air” about Wilbur and Orville Wright’s remarkable achievements leading to their historic 1903 Kitty Hawk flight, and concurrently, I’m just starting “Apollo”, which recounts NASA’s most remarkable achievement — perhaps the most remarkable technological achievement in our collective history, which of course is set against the backdrop of potential cold war nuclear annihilation.
What, if any thing, do these have to do with your and my financial futures? I think the likely answer is “probably more than anything you’ll see on CNBC.” It is very easy to be buffeted by the day-to-day and month-to-month tidal wave of news and information (most of it focused on making us worried so we’ll watch), forgetting that there were both times and tribulations long before ours – and that despite the most dire predictions of those days – we somehow survived and, not only survived, but in the process, saw the Dow Jones Industrial Average grow 167-fold (from it’s 1903 Kitty Hawk year-end value of 67) and 18-fold (from it’s pre-Apollo 1960 year-end value of 613) to its present 11,384 (as I write this).
In the end, I think pessimism and short-term thinking are the most corrosive agents of long-term wealth, and I think, more than anything else, a strong sense of both market and non-market history is one of the best, if not the best, antidote to such financial (and emotional) corrosives.
For a little more perspective, I would suggest this essay by Greg Easterbrook from the June 13th, Wall Street Journal, entitled, “Life is Good, Why Do We Feel So Bad?” The WSJ is a subscription-only site, but the essay is also posted on the Brookings Institute website where the author is a fellow. Click here to access.
So, in closing, despite the dire news of the day, despite a very poor June showing, and despite $145 per barrel oil and $4.00 per gallon gasoline, I have trouble being anything other than optimistic over the intermediate-to-long term, which is the only time period that I believe matters to your financial future. As illustrated by both the raging bull market of late 1999 (when both the market and investor sentiment were at all time highs and just months before both crashed) and the bottom of the bear in late fall / early winter 2002 (when there wasn’t a shred of market optimism left and just months prior to the greatest year I have seen in global equity markets), investor sentiment and recent market performance is not an indicator I’d hang my hat on, and not one you should hang your hat on either.
So, as you open your June statement, try to keep all of this in mind, and remember that the sun will come out again. It always has.
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As always, I’m happy to talk over the recent goings on in more detail, so please feel free to call or email. As (bad?) luck would have it, I’ll be out of the office from July 10th through July 18th, the day or two after the July statements arrive. However, I will be checking email periodically and will be available by phone. If you do need to talk to me while I’m gone, please call my assistant Kelly and she will make sure I receive your message.
The market notwithstanding, I hope you are having an enjoyable summer. As always, please let me know if you have any questions or if there is anything I can do for you.
Footnotes
1. For purposes of this hypothetical portfolio, the following indexes were used: equal positions (16.67%) in the following equity asset classes: MSCI EAFE Index, U.S. Micro Cap Index, S&P 500 Index, US Large Cap Value Index, International Small Cap Index, US Small Cap Value Index. Indexes can not be invested in directly and the returns do not account for any inherent trading costs.