Last year I mentioned on March 13th that I was laddering additional money into stocks over the drop. Then on March 23rd I wrote the following excerpt in an article called, “NOW IS THE BEST TIME TO PURSUE FINANCIAL INDEPENDENCE“:
“I know you may be thinking “why would I want to invest when the market is losing up to 10% each day?” The answer is that this may be creating one of the biggest buying opportunities of your lifetime and you need to be ready to invest. The market has proven itself to be a huge wealth creation machine over the last 90 years. There is likely an opportunity to buy in very low in the coming months.”
If we look at a total market index since I wrote the above, you can see that there has been around a 72% return from March 23rd last year by trading the tried and true boring and simple total stock market index!
Last March, I also bought small amounts of airlines, energy, and a couple financial stocks around the same time. Low and behold DAL is up 96%, UAL is up 104%, VDE is up 82%, SCHW is up 82% and DFS is up 230% since March 23 2020. Does this mean that I am a stock market genius?
Am I A Stock Market Genius?
Whenever I start wondering if I am a genius, I remember all of the stupid things that I have done. For example, the time I tried to read the printing on the bottom of a cup. I tilted it slowly and obliviously pouring juice all over the table in front of everyone. Maybe I was looking to see if it said, “Kobayashi Porcelain”. As much as I try to convince my wife that I am a genius, she gently reminds me that I am not.
Similarly for you, it can be easy to think that you are a genius when the stock market has been through more than a decade of almost uninterrupted running of the bulls. Everything you threw money at worked. Moreover, if corrections are like last year, well that was easy. Unfortunately, history shows that they are not. How would a decade of recession after this decade of boomtown feel? Yikes. It is important to objectively look at the reasons for your results rather than just the outcome.
Am I Right But For The Wrong Reasons?
What I knew about the total market last March is that I am primarily a long term broad market investor and stocks were way cheaper than they were a month ago. I also believed that panic was at high levels and had affected some sectors much more than others. There is an old adage to be greedy when others are fearful and be fearful when others are greedy. With a 30+ year investment horizon I figured that it was a good time to get a bit more money into the market.
However, I could not have imagined that the rebound would happen so insanely quick and that we would be around all time highs today. The federal government putting trillions of dollars of stimulus in play was not my game plan. It also should be noted that because I laddered in money, I came close but did not hit the exact bottom with every total market dollar. Shucks, I’m not a genius.
I offer that anyone who claims to be a stock market genius is selling something and you should be wary.
Lesson #1 Humility During Difficult Markets
Wait did I just say this is a difficult market? It sure feels like boomtown, how could it be difficult? In short, great market performance makes everyone feel like a genius and offers false proof through profits on almost any investment one made at the bottom of the pandemic. Speculation balloons most just before markets fall. Kurt Vonnegut once said “Just because you can read, write and do a little math, doesn’t mean that you’re entitled to conquer the universe.” Put into investing terms, even Warren Buffett understands that the best of analysis only ups his batting average. Even the best home run hitter only makes contact with the ball about 1/3 of the time he is up to bat.
This lesson about humility is to not let results make you reckless at the worst possible time. The individual stock picks outside the index that I mentioned above were made with less than 5% of my portfolio, comfortably post financial independence, and with substantial earnings and book value. Because while I like to think that I am right, I try to look at my own track record and see if I was right for the right reasons. I understand that even my best ideas, only up my batting average.
Why This Is A Difficult Market
Six stocks make up almost a quarter of the entire value of the S&P500 as I write this article (Apple, Microsoft, Amazon, Google, Facebook, Tesla). That makes a huge part of the market very concentrated on a few companies. Washington is talking about cracking down on many of these same companies. This makes the S&P 500 less diversified than ever before.
In addition to recent outsized performance of tech stocks, the returns across different market sectors have been diverging over the last few years:
Does this indicate that some sectors were affected much more than others during the pandemic? Will stimulus affect some differently than others?
As I write this article, the Covid 19 pandemic is very much not over. The US GDP is down year over year and unemployment is higher. Small businesses make up about half the GDP. The majority of small businesses claim that they will not be back to pre-Covid levels for at least six months according to recent census data (here). Interest rates sit right around zero! The federal government is buying up corporate bonds, and is literally sending people and businesses money to stay solvent. Another 1.9 trillion dollars in stimulus is proposed in 2021. In short, the economy is being propped up by free money lending, the printing of money, and non-existent interest rates that force money into stocks. With all of this, how are stocks performing?
Is A Recovery Already Priced In?
Less than a week ago the stock market was at… drum roll please… an all time high! The PE ratio of the SP500 is around 40. A year ago it was around 26. The average PE ratio of the SP500 over the last 100+ years is 15.88. This means that the market is being valued at about twice its long term valuation average based on earnings. Yes, this same pandemic battered market is marked up 100%. A speedy economic recovery feels already priced in and this does not seem healthy to me. It seems like a difficult market condition where consumer and investor sentiment may be detached from fundamentals.
Lesson #2 Don’t Throw A Hail Mary
During challenging market conditions, market inefficiencies can create crazy situations. As I wrote this article, a stock called Gamestop went up 1884% since the beginning of the month. This is a company that posted Q3 sales down 30% year over year. It is operating at a net loss and is shuddering its stores. It looks so rotten that hedge funds shorted the stock knowing the company is failing. However, a group of internet weirdos went long on this dog, squeezing the short sellers. How much is this company intrinsically worth? Is this a new paradigm or just a short term inefficiency? What will shares be worth in one year? The stock has now crashed and bounced a few times over the last week.
A friend recently shared that he has made 4x on his Ethereum crypto holding. He asked if I am going to get in. I responded, “why would I throw a hail mary when I am already winning the game”? Same with GameStop or the many IPOs of late 2020 that opened at 2-3X the predicted share price. Yes they may make some people rich but they may also break others.
This speculative behavior with little book or earnings value behind it is one of the hallmarks of challenging markets. My own opinion is that I don’t need it. You don’t need this risk to get to financial independence either. You can get there in other more repeatable and less risky ways. Why Throw a hail mary when you are already winning the game?
A Personal Perspective on Difficult Markets
Today, margin debt as a percentage of nominal GDP (debt to buy stocks) is at an all time high. Friends and relatives that never talk investing are suddenly asking me for stock tips. It seems like there is a belief that the government will not let companies fail or let stocks go down. I don’t know if the market is going to fall into recession this month, this year, or continue to grow for 10 years. However, I do know that every challenging market time that I have lived through is accompanied by a chorus of “this time it’s different.”
I was in college during the early 2000 dot com bubble and some were telling me to invest in anything online with any money that I could scrape together because you can’t lose. Some were even dropping out before graduation to get paid six figures to code for these internet startups that were gone less than a year later. I remember the real estate bubble before 2008. Multiple people told me with total sincerity that all you had to do to make money in real estate was get in.
All these times have a similar frothy feeling. I am reminded of the adage again to be greedy when others are fearful and fearful when others are greedy. I am certainly not as excited about stocks today as I was back in March 2020. At the same time, I am also not pulling all my cash out. Large market gains often happen in the late stage of bull markets after all. The path I am advocating is steadfastness. This brings me to my third lesson for investing during difficult markets.
Lesson #3 When In Doubt Stay The Course
Challenging times like these are the time to stick to moves that fit your personal investment strategy as opposed to chasing shiny objects. This market is frustrating for me. As evidenced above, I am fearful for what 2021 holds and the correct course has never felt more difficult to determine. At the same time, it is hard to fight the fed. The government is determined to stoke this market above pre-pandemic levels. As Covid vaccinations hit, there may also be an explosion of consumption from pent up demand. Am I the only one that is just itching to blow some cash at restaurants, concerts, and breweries? Then maybe follow that up with a haircut and a bunch of travel?
A general rule for investing and life is that the higher the uncertainty the more prudent it is to stick to one’s plan. Behavioral control may be the bane of every investor that underperforms the index. If clear evidence appears that changes the rationale of my plan only then will I review and adjust. I will keep my portfolio in the market to a level that feels appropriate to my long term risk tolerance and financial goals.
Fixed Income During Difficult Markets
If you are a 75/25 or 80/20 type Index/bonds investor, you have 20-25% of your cash in bonds or other fixed income like treasuries. This is like gospel to some. As interest rates have fallen the value of your higher yielding bonds has gone up. However, does purchasing bonds even make sense in 2021 with such low interest rates? Isn’t it at least worth considering that yields may drop to zero. In fact negative yields recently popped up while I was looking at T-bills last week in my Schwab account and I got the following warning message:
5, 10, 20, and 30 year TIPS (treasury inflation protected securities) are actually all negative right now. I suppose if you are betting on interest rates going highly negative you might want to buy bonds at a 0.1% return today. However, for me, I seriously question the risk versus reward of locking money up in any sort of longer term treasury or bond when interest rates are so low.
If and when a market correction happens, my cash could be tied up in a bond or treasury that has not matured yet and market bottoms happen fast. I’d rather have access to that cash to be nimble than have it tied up for 6 months or a year making 0.1%. Moreover, since my interest yielding and FDIC insured bank accounts (Capital One 360 and Marcus by Goldman Sachs) are still offering 0.4-0.5% yield on balances this seems more attractive to me than bonds, CDs, or treasuries. This is an example of something crazy happening right now in difficult market conditions. You can actually make a better return in a bank account than buying a bond?! Even gold which is a terrible long term investment looks interesting to me these days as an inflation hedge in this challenging market (not for return but as an inflation wealth protection insurance policy).
Evergreen Thoughts On Investing During Difficult Markets
To me this is one of the most challenging investment environments of my lifetime. Stocks could continue to fly high for years….or fall in 2021. In difficult markets, I try to stay humble. I look at whether my investments were right for the right reasons. I operate under the knowledge that even the best ideas only up my batting average. Hence I should be measured and diversified in my allocations. It can be tempting to throw a hail mary when difficult markets are making speculators rich. However, why take on outsized risk when it is often unnecessary to meet your goal? Lastly, steadfastness is a great course when conditions are very difficult and it is hard to plot a course. This is behaviorally one of the hardest things for the long term investor.
I am not a financial professional and none of this should be considered investing advice. On the contrary, part of the very point of this article is to keep steadfast to your strategy during challenging times and informed about what is happening 🙂
I hope this helps you on your investing path and would love to hear your thoughts in the comments as well.
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10 comments
In high school whenever someone would tell me how smart I was, I would always respond by saying I’m really not that smart, I’m just surrounded by idiots. I still think this is mostly true today in most respects. I didn’t panic and sell in March, and was surprisingly calm about the flash crash. The only reason I didn’t buy more was that I didn’t have a job for March through May and needed money for a cross country move. I am a bit worried about tech dominance in the S&P 500, so I have decided to split 50/50 between Vanguard Total Market (VTI) and Vanguard Value (VTV). Time will tell if this was a smart move. Who knows, as I said, I’m really not that smart, I’m just surrounded by idiots.
Haha, that’s funny Dominic. Yeah it is tricky to navigate these times and thanks for weighing in with your approach. Sounds like you are still pretty broadly diversified. Some want to point to historical data and say that anyone that deviates from straight buy and hold total market indexing is a fool, a market timer, etc. However, I think it is fair for even the most rational investor to point out that if truly abnormal times appear (negative interest rates for example) it might be foolish at some point to pretend that all is business as usual.
You are the best sub-genius FI blogger out there when it comes to investments! What do you think about going for a 20-yard connection at the end of the third quarter to try to shut down the risk of going to OT? We are tilting hard to emerging markets, international developed and are almost out of growth stocks. Basically all low CAPE ratio things.
Hey thanks Doug and that is interesting. I’d be curious to hear more about what areas you like internationally as well.
I haven’t been picking single stocks, my 401(k) is now almost 100% in international and EM indexes to achieve the international component of the tilt. I do own a couple Asian equities like PKX, it seems like Asia can emerge from the pandemic fastest because some of the countries like China, Taiwan, Vietnam, S. Korea etc. did things like wear masks (!) and had strong orders to stay at home (!!) and used advanced disease tracing programs (!!!) so now their governments don’t need to shoot money out of cannons and buy corporate debt.
Do you think extreme tilting makes sense? How are you thinking about gold? It is interesting that gold’s 30 year return could very well rival a 30 year treasury bond at this point.
Wow Doug you are making me work hard here 🙂 Both gold and internationals could probably be a whole post each but here goes.
Some of this for others since I know you know most of this. About 50% of the global stock market value is in the USA and the other 50% in foreign markets. Internationals have lagged US based for the past decade or so however, that could change. Heck from 1970-2008 or so, internationals outperformed the US (though some would call that cherry picking a timeline). Your point about the cash cannon and the US pandemic response is a good one. CAPE is perhaps one of the best predictors of future success from a value perspective and you are spot on that the average CAPE of the total market for many international markets is much lower than the total market average CAPE in the USA. This is another reason why many think that the USA returns will lag the rest of the world in the coming years. Of course others argue that the higher CAPE for USA based is justified because our developed market has less risk and is politically stable. I think that stability part starts to get slightly more debate-able today that in the past. There is data that suggests that even up to 40% or so in internationals makes one’s portfolio less volatile. Part of this is simple global diversification and part is currency and trade related diversification. All of this is to say that upping an international position is not a crazy idea to me. Do I think that extreme tilting makes sense. I don’t think that extreme anything makes sense to me right now in this difficult market (part of the main point of the larger post) but that is simply an opinion and gets back to my point about humility. To take this to a macro level, every empire has a lifecycle and the USA is no different. There will become a point where a shift to internationals will be the obvious choice as other countries rise and the US empire declines. To each their own on predicting that one haha. Also, I assume you are holding the internationals in your 401K since they tend to be a bit less tax efficient than domestics which makes sense for most investors.
As far as gold, it has a poor track record for long term performance. It is of course a commodity that generates nothing of value like an equity does. However, it has historically been viewed as a safe haven and can go up dramatically when investors get really fearful. I could see gold doing well if another black swan event hits or the greater economic woes in the US overtake government stimulus because there will be no dry powder left to stimulate anything. The fed is targeting 2% inflation right now. With cash cannons, debt, and wild interest rates, higher inflation is one possibility. Hence I see a small position in gold as more of a hedge against losses in my broader portfolio and against the possibility of high inflation / weak dollar.
As you know, investing in both gold and internationals need to be looked at based on one’s broader portfolio strategy rather than just seeking shiny objects. The golden butterfly portfolio for example uses gold in a different way than the pinwheel portfolio for example.
I know this is not a quick answer but it at least shares some of the nuances in my way of thinking Doug.
Also, for all you reading this, remember that I am not a professional financial advisor so none of this should be misconstrued as advice for anyone’s specific portfolio but rather seen as thoughts from one experienced investor.
as you know i am a stock investor. 60% of our assets are in individual stocks. for the situation right now i consider us to have a big lead. the stock portfolio is up 350% the past 5 years compared to about 98 for VTSAX. i think it is full of companies and businesses with lots of future promise as a long term investor. that being said we’re staying the course with these companies unless something changes within them individually. having a big lead and seeing it that way is key for me right now. it allows to view any pullback as almost bound to happen. whatever the pullback is i’m betting this group is still trouncing the index on the other side of it. we shall see.
i know what you mean about cash and bonds. having our big lead i just deployed a bunch of cash last fall into stocks and preferred etf’s. those preferred shares are kind of volatile but we choose to own them where most people would ordinarily own bonds. the yields are 5% or better so at least i’m getting paid for taking the risk. as for things like the cape ratio how much of that is actionable? the damned thing passed 28 a couple of years ago and we’ve made a helluva lot of money since then. i hear people talk about it but always want to know “that’s nice. what did you DO? how did it work out?”
how about you? did you make any moves or ever made any because of the cape?
Thanks for reading and weighing in Freddy. I have watched you post your picks now for a couple of years and totally smoke the index which makes your perspective all the more interesting. Your idea of viewing the appreciation as an insurance policy of sorts and your focus on the long term impact of the companies that you are invested in sounds like a strategy that will prevent panic selling if/when there is a pullback of the broader market over coming cycles. I would also argue that the portfolio is pretty heavy into growth stocks so the high alpha may be because of high beta right? Growth stocks have crushed it over the past few years. In other words, there is no arguing with your results but it is also hard for me to recommend someone try to mimic it with their entire retirement savings over 30 years for example. Do you think that is fair? One thing is certain, with your performance, if we ever meet up for a beer I am going to ask you to buy 🙂 haha
You bring up a good point about the CAPE because it is usually a 10 year historical look at average P/E intended to capture multiple market cycles…but one could argue that because we have been in a decade of boomtown a 10 year average PE has not adjusted for anything. For value investors, CAPE is not a bad measure of a stock’s underlying value. It did get Shiller a Nobel prize which is at least cool. It is something I look at among other factors when buying stocks but I don’t go buying or selling en masse when it moves around or anything. I think about it right now because some areas of this pandemic market have much more value than others. It factored into me looking at those energy stocks last year for example. However, I would offer that much of this highlights your perspective as a stock picker who holds lots of growth areas versus someone who is a broad market value oriented investor with most of his portfolio.
I hope this seems fair and I appreciate your perspective. These different perspectives are part of why I enjoy getting ideas from lots of sources.
I appreciate the detailed reply! It is pretty peculiar that most of the FI community is all in on VTSAX or S&P only investing. We could have just as easily been sitting in Europe a decade ago buying only FTSE Europe funds for many of the same reasons argued to buy only S&P 500, seems like one would always want something close to the average of foreign and domestic returns.
That said, I guess the same logic goes for “extreme” tilting. While it’s not as extreme as, say, putting your life savings in GME, it’s about as bold as having 90% of your dough in the S&P. Humility would probably say tilt enough to hit a double if you are right rather than looking for a home run.
Gold is another animal. It’s hard to wrap your head around owning something with very low expected returns and high standard deviation but extreme diversification benefits. Good luck with navigating this most difficult market! I’m a moron and don’t construe this as investment advice but another interesting insurance policy is buying deep out of the money long term puts on the S&P or other indices. If I were FI I might consider layering some puts on to protect against black swan events when volatility is low (like 20%+ drawdowns). Gold may be a much better hedge or BTC or cow chips though, who knows.
You know Doug, I thought of your comments when I read this opinion piece about whether Jack Bogle would invest in US stocks today (this bold text is a link to article). US versus rest of world investing is something I continue to think about and may write on in the future.
Also, your point about other ways of hedging and long term puts is interesting. Of course like any insurance policy, you pay a premium just to carry it. A friend of mine has used inverse index ETFs to reduce his market exposure in times of great uncertainty. He pays the management fee as a premium but does not trigger a gain or loss on his long held investments which have appreciated hugely over the years. So many weird tools out there. Be well.