Living In The Present

The secret of health for both mind and body is not to mourn for the past, nor to worry about the future, but to live in the present moment wisely and earnestly.

Buddha

It’s that time of year again, time to cast the runes, consult the iChing, shake the Magic Eight Ball and read the tea leaves. What will happen in 2019? Will it be as bad as 2018 when positive returns were hard to come by, as rare as affordable health care or Miami Dolphin playoff games? Will China’s economy succumb to the pressure of US tariffs and make a deal? Will the Fed keep hiking rates? Or will they be forced to cut to stave off a recession? Will the Dow keep jumping in 1000 point increments? Will Europe hold together a while longer or will Italy blow the whole project? And who will dare to coach the Dolphins next year?

All interesting questions and ones that can only be answered truthfully with the three hardest words in investing (and life): I Don’t Know. I didn’t know what was going to happen in 2018 and I have no more clarity about 2019. Luckily for me no one else saw the Mack truck of volatility that hit markets last year either. Who predicted that almost every major asset would be down on the year, some by bear market proportions, despite 3% GDP growth? Who predicted that gold would outperform all the major stock indexes except the NASDAQ  – but still be down for the year? Did anyone predict the 25% drop in crude oil and the 13% rise in natural gas prices?

Predict the future? We can’t even agree on the present. Is this a bear market? The S&P 500 fell 19.8% peak to trough on a closing basis but the usual marker for a bear is -20% and the market only breached that level on an intra-day basis. So, does that qualify? Did the S&P already have a bear market? Close enough if you ask me and besides there were plenty of markets that breached the -20% level at some point in the year. US small cap stocks, emerging market stocks, crude oil, Japanese stocks, the EAFE index of foreign developed markets, Hong Kong stocks, European stocks, timber, the Goldman Sachs commodity index and Chinese stocks all entered bear market territory at some point during 2018. And that is a partial list for sure. So, let’s just say that it wasn’t a good year no matter where you parked your cash unless it was all in CDs or short term bonds of some type.

Further clouding the outlook for 2019 is the basic fact that we can’t even say for sure why all these assets fell last year. In some cases we can point to things that seem obvious – Chinese stocks fell because of tariffs – but even in those cases the accepted explanation often comes up wanting. The most widely cited explanation for US stock weakness has been a slowing US economy but actual evidence of that is pretty hard to find. Politics is also often cited as an explanation but the divided government ushered in by the mid-term elections has in the past been pretty bullish for stocks. Gridlock is good.

The Fed’s rate hiking campaign has also been cited frequently as a cause but the pace of hikes has been leisurely to say the least. Is the economy really so fragile that it can’t handle a 2.5% Fed Funds rate? For that matter, with almost no volume in the Fed Funds market, does it really even matter? Isn’t the positive of higher interest rates for savers potentially an offset to higher rates for borrowers? The Fed’s balance sheet reduction has also been cited but if anyone can draw a direct connection between the balance sheet and the stock market I’d like to hear it. Charts showing the balance sheet superimposed over the S&P 500 don’t count. Correlation isn’t causation.

So, why do we waste so much time trying to predict the future? Why do we read all these outlook pieces year after year? It sure isn’t because they’ve been so accurate in the past. Of the 19 Wall Street strategists tracked by Bloomberg last year exactly none of them predicted the right direction for the US stock market much less the magnitude of the move. As a group they predicted the S&P 500 would be up 8% in 2018, a miss of double digit proportions. As a group, these strategists haven’t predicted a down year this entire century. And they aren’t any less bullish on 2019 with a median predicted gain of 19%. If they turn out to be right it will be sheer luck.

It is this obsession we have with trying to predict the future that gets us off track, convinces us that there is some magic strategy or strategist who will tell us where exactly we should be investing TODAY. Adjusting your portfolio based on what someone thinks will happen in the future is a recipe for failure. Your investment strategy shouldn’t change because some crystal ball gazer on Wall Street puts out a bullish – or bearish – outlook. Tactical changes – alterations based on short term considerations – are different but even then, you need to make changes based on evidence. The latest report from a brokerage firm doesn’t qualify.

If the market gyrations last year caused you angst, you probably need to reassess your strategy. That doesn’t mean you need to change your strategy completely. If you held a diversified portfolio of different assets – global stocks, bonds, real estate and commodities – you might need to put more in bonds and less in risk assets but you still need to stay diversified. Despite owning most of those things that went down last year – that was kind of hard to avoid if you owned a diversified portfolio – Alhambra’s moderate portfolios were only down low to mid single digits last year (results vary depending on various factors). That is true because our moderate portfolios had 50% in bonds, a position that everyone hated until bonds rallied and stocks tanked in the fourth quarter.

You should also probably consider that this selloff in risk assets was actually pretty mild. A 20% correction is just that, a correction. Corrections – a drop of more than 10% but less than 20% – happen roughly every 18 months or so. Real big bear markets are usually – but not always – associated with recessions. Just in case you’ve forgotten the S&P 500 fell by roughly half in the last two recessions and I have no doubt the next one will produce a similar result. So, if this correction caused you to lose sleep, imagine how a drop of double or even triple this one would make you feel. Your strategy needs to take into account worst case scenarios and this wasn’t it.

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Disclosure: This material has been distributed for informational purposes only. It is the opinion of the author and should not be considered as investment advice or a recommendation of any ...

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