Staying the Course Amid Pullbacks and the Folly of Predictions

 
During times of heightened volatility, as we’ve seen throughout 2022, The Mather Group, LLC (TMG) aims to share a perspective that is grounded in a long-term, evidence-based view of the facts. We strive to be a voice of reason that helps clients remain calm, since we believe one of the biggest mistakes investors can make is to emotionally sell and lock in permanent losses during moments of stress.

As a reminder, bear markets and other pullbacks in the market are completely normal, though unpleasant. They are also the price that is paid for higher returns over time. As the chart from BlackRock in TMG’s Second Quarter 2022 Market Commentary showed, it is reasonable to expect many bear markets over the course of a lifetime. These market pullbacks can be longer than expected, historically ranging from 3-34 months on the way down, with longer recovery times. However, the subsequent bull markets lasted even longer and generated tremendous wealth for investors who stayed the course.

In fact, during the past five-worst declines for the S&P 500 Index, the subsequent five-year recoveries were very strong, as shown in our June 2022 article, Perspectives on Recent Economic and Market Events.

An important point needs to be reiterated about this historical analysis. If an investor was not able to stay invested through a prolonged bout of volatility and they missed a handful or more of the best days in the market (which often took place during periods of pain), their subsequent returns were substantially lower. We also believe, and various studies* have supported, that this is more likely to occur for investors who go it alone. 

Knowing this, we focus on helping to ensure that clients aren’t impacted by common pitfalls related to market psychology. When markets are going up, investors tend to get greedy and can take on too much risk while trying to chase high returns. Recency bias—placing disproportionate emphasis on recent events (in this case, upwardly mobile markets)—contributes to this misguided behavior. In reality, bear markets and other market pullbacks are often part of the investing experience that we must withstand. When these occur, we coach clients to avoid the temptation to reduce losses by withdrawing from the market. Again, market cycles are normal; we know that downturns will eventually be followed by upturns. So we rely upon historical evidence and our knowledge of behavioral finance to steer our clients away from emotional, short-sighted decisions.

Opposed to timing the market, we believe the best course of action is to ride out the storm and to proactively respond through rebalancing (potentially buying undervalued investments), tax loss harvesting (helping with tax efficiency), and pursuing strategies like Roth conversions where appropriate, so that clients can reduce their taxes in the short-term and also enjoy more tax-free growth in the long-term as markets recover.

Despite reiterating our evidence and beliefs, some insist that market pain can be predicted or prevented, pointing to outlier examples of an investor or strategist who got lucky timing both their exit from and re-entry into the market. However, as the following examples will illustrate, even those regarded as experts on the economy and markets have little to no valuable insight about the future when it comes to predictions. 

Take the Federal Reserve (Fed) for instance. Many of us remember that just a few years ago, the Fed was worried about not being able to generate enough inflation, and in fact, was willing to overshoot their 2% long-run inflation target. Obviously, they were unable to predict an upcoming pandemic, war, and supply chain disruptions, but they more than met their target with the Consumer Price Index (CPI) at 8.3% year over year as of the recent reading. 

Now they have reversed course and are hiking interest rates to attempt to tame inflation, which has contributed to the recent market downturns. If they could misread the situation before, it is entirely possible that inflation could fall faster than they expect, necessitating rate cuts. So, we view the Fed’s ability to control inflation as the illusion that it is, though their decisions must still be monitored due to the impacts that eventually flow from them.

Complicating matters, the following chart from 2019 shows that markets aren’t good at predicting Fed actions either. Fast forwarding through time, we know that the 10-year Treasury note yield ended 2019 closer to 1.5%, showing how incorrect these expectations were.

Wall Street strategists often don’t have an enviable track record either. Consolidating data that we found in the public record over various snapshots in time, we found that from 2018–2022 (so far), only 10 of 94 estimates were within 100 points of the actual S&P 500 year-end value (represented by the 9/23 value for 2022).

While these track records don’t inspire confidence, they also fail to account for the fact that the strategists are constantly changing targets and anchoring towards recent events, which may not capture the true magnitude of past diversions. To illustrate, as of 9/23/22, the S&P 500 was around 3,693 and Goldman Sachs had just cut its estimate from 4,300 to 3,600, which coincidentally is much closer to the value today; Goldman, of course, is not the only firm that has done this. This demonstrates how much easier it is to tell investors what just happened in hindsight, as opposed to predicting the future and inevitably failing. 

Taking these findings as a whole, we believe that predictions should be taken with a grain of salt, and all things seem obvious with the benefit of hindsight. Given that the future is unknowable, and always finds ways to surprise, we will continue to adhere to the time-tested methods upon which our philosophy is built. We acknowledge that these times can be trying, but your trusted TMG advisor is here to help you navigate them, so that we can help you reap the benefits of subsequent bull markets.

Please let us know if you have any questions.

* DALBAR Quantitative Analysis of Investor Behavior (QAIB) Report; Morningstar, “Mind the Gap: A Report on Investor Returns in the U.S.”; “The Behavior of Individual Investors,” by Brad M. Barber and Terrance Odean of University of California; “Trading is Hazardous to Your Wealth: The Common Stock Investment Performance of Individual Investors,” by Brad M. Barber and Terrance Odean of University of California 

The Mather Group, LLC (TMG) is registered under the Investment Advisers Act of 1940 as a Registered Investment Adviser with the Securities and Exchange Commission (SEC). Registration as an investment adviser does not imply a certain level of skill or training. For a detailed discussion of TMG and its investment advisory services and fees, see the firm’s Form ADV on file with the SEC at www.adviserinfo.sec.gov, or on the firm’s website at www.themathergroup.com. The opinions expressed, and material provided are for general information and should not be considered a solicitation for the purchase or sale of any security. The opinions and advice expressed in this communication are based on TMG’s research and professional experience and are expressed as of the publishing date of this communication. All return figures and charts shown are for illustrative purposes only. TMG makes no warranty or representation, express or implied, nor does TMG accept any liability, with respect to the information and data set forth herein. TMG specifically disclaims any duty to update any of the information and data contained in this communication. The information and data in this communication does not constitute legal, tax, accounting, investment, or other professional advice. Investing involves some level of risk. Past performance does not guarantee future results.

An index is a portfolio of specific securities, the performance of which is often used as a benchmark in judging the relative performance of certain asset classes. Indexes are unmanaged portfolios and investors cannot invest directly in an index, as an investment vehicle replicating an index would be required. An index does not charge management fees or brokerage expenses, and no such fees or expenses were deducted from the performance shown. Please feel free to contact us for additional information on any indices mentioned.

Indexes

• Standard & Poor's (S&P) 500 - A stock market index that measures the stock performance of 500 large companies listed on stock exchanges in the United States.
• Consumer Price Index (CPI): The CPI is a measure calculated monthly by the Bureau of Labor Statistics that examines the weighted average of prices of a basket of consumer goods and services, such as transportation, food, and medical care. It is calculated by taking price changes for each item in the predetermined basket of goods and averaging them. Changes in the CPI are used to assess price changes associated with the cost of living.