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“There is a thin line that separates laughter and pain, comedy and tragedy, humor and hurt.” – Erma Bombeck
In times like this, where everyone seems to panic out of not just asset classes, but also strategies, introspection is a worthwhile endeavor. After having been on the road for nearly two years now and presenting to thousands of advisors on our award winning papers related to predicting stock correction and volatility (click here to download), I can share a great truth I’ve learned:
Few truly buy low to sell high. Nearly all attempt to buy high, and sell higher.
Anyone with access to a Bloomberg terminal will clearly see this when analyzing mutual fund asset growth over time. Performance for some strategy/asset class attracts attention, assets then follow with a lag. Then, the cycle begins to turn against that strategy/asset class, performance dwindles, and money (again with a lag) sells until the actual bottom occurs. It is remarkable when one steps back and looks at asset classes or strategies which have drawdowns, and the lagged response money has to getting out at quite literally the exact wrong time. Buy low, sell high means to buy AFTER a severe drawdown has taken place. The reason why most asset allocators tend to have lackluster returns over very long cycles beyond the small sample we all live in is precisely because of this type of allocation behavior – selling after the decline rather than buying into it.
Of course, one must in turn define what “severe” means. There is an old saying on the Street that “your largest drawdown is always to come.” Some define it by percentage, but more importantly one should view drawdowns in the context of what actually is happening in the market environment. Stocks so far in 2016 have had essentially their worst start to a year in history going back to 1928. We are quite literally living history as an outlier environment overwhelms the investing community. Does one sell, or buy into this? From the standpoint of the environment, there is one very clear fact to consider – passive indexing has resulted in tremendous complacency. That, combined with the Fed “put” belief likely means the bigger drawdown in US stocks is in front of us not behind. The environment still favors defense in the near-term.
However, many strategies and asset classes already have had a massive decline, notably active tactical allocators who suffered numerous false positives in their methodologies. Somehow though, I get the feeling there is much more divesting in those beaten down large-drawdown plays than investing. Those who understand what they are investing in and more importantly why they are investing in it can shut out the noise and fear, and take the “brave” step of buying low when no one else does.
Of course, knowing the exact day to buy into a large drawdown is impossible, but averaging in usually helps resolve that issue over time. Fear is palpable here. Having the courage to be rational and recognize that opportunities come after big declines is ultimately how to outperform over long cycles.
Happy 2016! It’s been a strange year already.
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