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Can the market bounce back?

Larry Swedroe explains the cyclical nature of market declines and rebounds, and why a financial plan that incorporates that expectation can better withstand expected losses and capture eventual returns.

Transcript

Tim Maurer:
Hello and thank you for tuning into Ask Buckingham, an ongoing video podcast series where we invite thought leaders across many disciplines of wealth management to respond to the questions on your mind. My name is Tim Maurer and I have the privilege of hosting these short discussions as the Director of Advisor Development for Buckingham Wealth Partners. I want you to know that I’m also a wealth advisor with more than 20 years of experience and I’m a client of the firm.

The volume of information coming at us these days is so vast, and the pace at which that information arrives is so fast, that it’s a struggle to keep up with what you need to know in order to make the best decisions for you and your family at this time. Our hope, therefore, is that this ongoing conversation will become a source of clarity in the midst of confusion and chaos, and provide insight that helps you better understand what’s going on in the world financially and otherwise.

Today we’ll be hearing from Larry Swedroe, Buckingham’s Chief Research Officer. Here’s the question we’ll be tackling, Larry, these seem to be particularly serious and painful losses. Some of these down days are just mind-blowing. Is there any historical precedent to suggest that this market’s actually going to come back?

Larry Swedroe:
Yeah, Tim, here’s the data that people should be aware of…we get a market correction, 10% is the standard definition, literally, on average, every year. But we’re seeing much bigger losses. We get a bear market, which is 20% or more, that’s somewhere every three to five years. We get these super crashes, we’ve now had them in ’08, 2000 to ’02, and the last one before that was ’73/’74. So this is now the fourth in the last, let’s call it 40 years, so let’s call it once a decade roughly we should expect that. So it’s not that unusual. You need to be prepared for it.

That doesn’t make it any less painful though while we’re experiencing it. That’s a natural reaction. It helps, of course, if your plan has already anticipated that and you know you can survive through this.

Tim Maurer:
Well let’s talk about that for a second Larry, this notion of anticipating it because I think there really is a difference here. It seems to me that most of the financial advisory voices out there speak to this notion of almost changing your strategy, trying to shield investors from as much of the downside and then change the investment strategy again to benefit as much as possible when the market goes back up. But you seem to be suggesting something different. We should be having a proactive strategy that takes both our propensity to absorb losses, and our desire to make gains, in one single strategy that doesn’t change over time. Is that correct?

Larry Swedroe:
Yeah. “Battles are won,” as Napoleon, probably the greatest general, or certainly one of them, of all time said, “are not won on the battlefield but in the preparation stage. When you’re designing your plan.” If your plan ends up taking more risks than your stomach can handle or you have the ability and willingness, or need to take. When that crisis inevitably comes, your stomach likely will take over and you will abandon your plan, and panic, and sell. You’ll commit what I call portfolio suicide. I use that term because the likelihood is you will never be able to get back in or if you get back in it’ll be way after the markets have recovered, because there is literally never a single day when it looks safe to invest, so you need to be prepared. Your plan has to incorporate this certainty to make sure that when it does happen you don’t panic and sell. That’s the first thing.

The second thing you need to understand is market returns, in any one year, are not normally distributed like The Bell Curve where the average return is about 12% in any one year. Then most of the returns, you would think, would be somewhere near that 12%. The fact of the matter is very, very few years are even within 4% or 5% of the 10% compound return that we receive. Most of the data is in the fat tails.

Now the good news is we only get that left tail once every three, five years and the really far left tail once every 10. The far right tail, where we get years of more than 20%, happen with much greater frequency. They tend to occur right after the crisis because risk premiums had gone way up, which means PE ratios collapse, along with earnings, and that’s what causes this double whammy. Earnings go down, and how much you’re willing to pay for those earnings go down, and stocks collapse. Well when the economy starts to recover, or even before, the first thing that happens is people’s willingness to take risk starts to go up and they’re willing to pay more for those earnings. Then the earnings quickly recover out of recessions very quickly. Then you get stocks skyrocketing.

In 2003 through 2007 we had five of the best years ever for the market. I remember in that period there’s one great example, emerging market funds, depending upon which ones you used, were up 3 to almost 600% in just five years. So you can get those kinds of recovery, but the only way you can get them is if you’re there all the time. You have to be like the deer hunter, you can’t just show up at 8:06 and know, all right, the deer’s going to show up and you get to shoot them. You have to be there at 4:00 in the morning sitting in your blind, waiting patiently, so you’re there when the deer shows up. That means not panic selling.

Tim Maurer:
Sure. So Larry what do you have to say to investors who, today, feel like, “Man I’ve already seen a lot of bad stuff happen in the market and it looks to me like the worst is still yet to come.” What do you have to say to those investors who might be fearful of what is to come in this market down slide?

Larry Swedroe:
The first thing to remember that I would say is this, ask yourself this question, list all the things that you think will happen. Then ask yourself, “What do I know that the market doesn’t know? What do I know that Warren Buffett, all these hedge fund managers, institutional … that they don’t know these very same things?” If they know them it must mean that the market is already incorporating that information, it’s best estimate of what they think will happen. If they thought things were going to get much worse, then prices would already be lower.

Lastly, I think one of the great anomalies, maybe the greatest anomaly in all of finance Tim, is this, if you ask anyone who they think the greatest investor of all time is, likely they would say Warren Buffett. Yet not only do they fail to take his advice, they tend to do the opposite. Warren Buffett says this, “Never try to time the market, but if you’re going to do it be greedy when everyone else is fearful,” which is now, “and be fearful when everyone else is greedy.” And I’ll add Peter Lynch may be the second most likely person people would say was the greatest investor ever. He said he never met a single successful market timer in his career. He was always 100% invested in equity. So I would say if you don’t want to take my advice take that of Peter Lynch and Warren Buffett, perhaps two of the greatest investors we’ve known.

Tim Maurer:
I think I’ll take their advice and I’ll take yours too. Larry, I appreciate it. You’ll get a kick out of this story.

On Monday our boys were told that they were going to be home from school for an indefinite period of time. We saw it as a potential teaching opportunity. So on this past Monday, the 16th, we started two little investment accounts, one for each of the boys. Of course that was one of the worst days we’ve seen since 1987. Then the next day the boys looked at their returns of 5% in each of these little portfolios. They looked at me and said, “Man this investing stuff is easy.” So it’s just funny the different perception that we have based on what the market is doing right now and what we anticipate it do into the future.

Well, thank you so much, Larry.

Larry Swedroe:
They’ll get another lesson when they check their account at the end of today.

Tim Maurer:
That’s a great point. Well, thank you again. And thank you for tuning in to this episode of Ask Buckingham. If you have a question that you’d like to see us address you can do so by navigating to the website www.askbuckingham.com, or emailing your question to question@askbuckingham.com, or heck, make it easy and just click on the upper right-hand corner. It’ll take you directly to the website. Remember that there are no dumb questions but unfortunately, there are plenty of poor answers out there. Our hope is that giving you straight answers to your questions you’ll be able to apply that knowledge in pursuit of good decision making. So please follow us and, by all means, ask Buckingham.

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