February 19, 2019
The Wall of Worry
Please read important disclosures HERE.
February 19, 2019
Please read important disclosures HERE.
This article is an updated version of one shared with clients in 2006. We believe its message still applies and serves as a timely reminder in today’s world environment.
An old adage on Wall Street says that “markets climb a wall of worry.” Simply put, this means that securities markets need the continuous presence of troubling issues in order to continue moving higher. Today, fluctuating energy prices, hurricanes and wildfires, terrorism, Washington dysfunction, unprecedented budget deficits, and global warming have created an elevated level of fear in some investors, driving them to avoid making any new investments or to move into cash “until things settle down.” While today’s problems deserve our concern and consideration, do they justify delaying investment decisions?
A quick walk through the recent past may help us to answer this question and to recognize the truth in that old adage. During the decades of the 1950s and 1960s, the U.S. stock market (as measured by the total return of the S&P 500 Index) rose 14.7%1 per year on average (arithmetic – used throughout this article). Many might be tempted to think back on this period as one of great optimism and innocence (the Ozzie and Harriet years) having just come out of the Great Depression and World War II, and therefore, supportive of ever-higher stock prices. However, significant troubles were constantly present throughout these years: the Cold War and prospects of nuclear annihilation (remember bomb shelters and duck-and-cover drills?), labor disputes, the Korean War, the Hungarian revolution of 1956, the Suez Canal crisis, and Russia beating the U.S. into space with the launch of Sputnik 1 during the 50s. Following these monumental events we had the U-2 spy plane crisis in the Soviet Union, the Bay of Pigs fiasco and the Cuban missile crisis (those bomb shelters and drills again), construction of the Berlin Wall, John Kennedy’s assassination, Martin Luther King’s assassination, Robert Kennedy’s assassination, the Arab-Israeli Six-Day War, the Soviet invasion of Poland, and the Vietnam War in the 60s.
A quote often credited to John Lennon refers to the 1970s as a “bummer of a decade,” and relative to others of the recent past, it certainly was. But even the 70s saw stock returns average nearly 7.5%2 annually, although rising inflation ate away the real value of this growth. This return was achieved in the face of some extreme headwinds: the Yom Kippur War and the resulting Arab oil embargo, Watergate and the unprecedented resignation of a sitting U.S. president, a stagnating economy combined with rising inflation (something so new that we needed a new term to describe it: “stagflation”), more Vietnam War, terrorist hijackings of airplanes and Israeli athletes at the 1972 Munich Summer Olympics, a second oil crisis in 1979, the fall of the Shah in Iran and the U.S. embassy hostages, and the Soviet invasion of Afghanistan.
Even during the 1980s and 1990s, when the S&P 500 averaged an impressive 18.6%3 annual return, stock prices were still forced to climb a steep wall of worry. We started off the 80s with a significant recession, exacerbated by a Federal Reserve that was compelled to raise short-term interest rates as high as 20% to choke off chronic inflation. We also saw one of the most devastating stock market collapses in modern history in 1987, which wiped out around 25% of the stock market’s value in just two days4. The 90s also started off with a recession (which was one reason George H. W. Bush failed to get re-elected), immediately followed by the first Gulf War, the terrorist bombing of the World Trade Center parking garage, and the global financial crisis caused by the Russian debt default, and later, the implosion of hedge fund management firm Long-Term Capital Management.
Interestingly, the first decade of the new millennium again started off with a recession (2001), compounded by the bursting of the dot-com technology stock bubble (with the S&P 500 dropping nearly 44% from April 2000 through September 2002) and the horrors of 9/11, followed by the second Gulf War, hurricanes and tsunamis, and a strong spike in energy prices, among many other incidents. These events were followed by a second stock rout and deep global recession during the global financial crisis of 2008 when the S&P 500 collapsed slightly more than 50% from peak to trough.5 Yet, despite this calamitous start to the new millennium, the S&P 500’s total return from 2000 through 2018 has been about 6.4% annually6— not spectacular, but far better than the disaster many predicted. Globally diversified investors following a disciplined investment approach (such as that employed at B|O|S) also achieved significantly positive returns on average over this same period.
In short, economic and political instabilities have been and will likely forever be part of our world. Some problems may recur and new ones will arise over time, but the impact on our economies and markets remains the same. Markets and investors adjust quickly, and today’s uncertainties are readily reflected in securities prices. For example, the yield on a 10-year U.S. treasury bond remains at a low 2.7% as of this writing (2/14/2019). As for stocks, while the recent bull market has the S&P 500 stocks trading at a premium to its long-term average price-to-earnings (cyclically-adjusted price earnings, or CAPE) ratio, value stocks look relatively cheaper than the growth stocks that have dominated recently, and foreign stocks in general are trading a discounts to their historic CAPE ratios. Unlike during the 1970s, inflation remains in the 2.0%–2.5% range, far lower than the 4%–5% average inflation rate we endured over the prior 50 years.
At times like these, it is important to remain focused on one’s personal and financial goals and the strategies employed to help achieve them. For investors, this means sticking with a sound, time-tested investment discipline that has been customized to match their return needs, risk tolerance, goals, and time frames. Rather than giving in to panic, we counsel our risk-tolerant, growth-oriented clients to embrace times of uncertainty and fear to continue with a well-thought-out, disciplined investment strategy by prudently adding attractive investments to their portfolio that others are selling in panic. For risk-sensitive clients who are focused more on capital preservation, a modestly reduced allocation to stocks in some cases per our Risk Adjustment Strategy (RAS), combined with full funding of near-term cash needs can help to protect capital while still allowing continuous participation in markets. These strategies may result in higher growth of assets over time, less costs, and a steadier, more certain march toward achieving one’s investment objectives. Remember that only the investor who chose to remain fully invested in the S&P 500 received the returns noted above. An investor choosing to get out of the market even temporarily had a very high probability of receiving much lower returns.
As importantly, we encourage our clients to choose quality of life over stress and not to let troubling world events delay them from moving forward toward their personal goals — ones that add fulfillment and meaning to life. Financial assets are but one means to this end. Turbulent times tend to help us focus on what’s most important. Use these periods to review your own big picture issues. How and when will you use your time, skills, and worldly treasures to achieve your goals? What personal or family desires remain incomplete or unfulfilled? Have you shared these with your family and advisors? Are you still on track to achieve them in the time frame you desire? Take advantage of your next discussion with your B|O|S team to share your thoughts and questions in this area. We stand ready to assist you with substantial investment and financial planning expertise by providing analysis, guidance, and resources in many areas.