Is This Time Different? Questioning Long-Held Market Axioms

April 22, 2020


Looking at things through the lens of market axioms


Over my years of following the markets and trying to become a better investment manager, I have accumulated a long list of market axioms. Every time there is a big bullish or bearish period, the question always comes up - is this time different? The generally accepted answer is no, "this time" is rarely, if ever, different. Yet, if anything could be the impetus for something different, surely the Coronavirus should qualify. It is affecting our lives in ways no one has experienced before. It has created market action that is very unusual with massive government responses. This bizarre environment has, in turn, led me to seriously consider if this time might be one of those rare "different" cases.


To try and make some sense of the moment, let's look at things through the lens of some selected investment axioms.


1. Emotions have no place in investing. You are generally better off doing the opposite of what you “feel” you should be doing. Because the human toll from the virus is so real from a health standpoint - and then combined with the economic pain for small businesses and the mass of individuals struggling with unemployment, it is hard to imagine a recovery that resembles anything like pre-virus times in the foreseeable future. Today in Tokyo a famous "obento"

restaurant closed after 150 years of continuedly serving meals for visitors to Japan's most famous Kabuki theatre. My neighborhood in New York City is nearly all made up of small, privately owned businesses. Many, if not most, will probably not reopen. The fabric of things will change. I question the wisdom now to invest opposite this feeling.


2. Market valuations (except at extremes) are very poor market timing devices. The valuations being referred to here are usually metrics for deciding whether the stock market is cheap or expensive. The most common is the price to earnings ratio but there are many others. In practice, something that is too "expensive" or too "cheap" can stay that way for a very long time. Well beyond any practical value in deciding when to buy or sell. But let's focus on the part in parenthesis "except at extremes". The market was overstretched to extremely high valuations early this year which most likely contributed to a fragile situation when an unforeseeable catalyst arrived. Recently, most sectors of the stock market traded at very low valuations - but are they low enough to suggest a bottom? Probably, if the economy can reopen in a reasonable time period, but the odds of the opposite are fairly high. A second or third wave makes the odds even worse. Since the future is more impossible to predict now than usual, waiting until things become more clear seems like the way to go.

3. There is no value in daily media commentary – turn off the television and save yourself the mental capital. Normally I can not agree with this more, even the most steely investment mind can be tested by a lot of hype one way or the other. If the current consensus matches your views, the reinforcement of the media can make one overconfident. If the consensus is counter to your views, hearing the opposite over and over can shake your resolve. Better to avoid the hype and stick with solid analysis. But this virus issue is different because of the outcome and the timeframe is everything. Changes in how this plays out will drastically alter the future for our lives and the markets. Therefore, closely following the news seems absolutely necessary. With so many conflicting opinions, this has been difficult - especially because so many of these opinions seem to be heavily influenced by underlying biases.

4. No investment strategy works all the time. The trick is knowing the difference between a bad investment strategy and one that is temporarily out of favor. There are a couple of very prominent investment strategies that come to mind for this one. The first is the trend in recent years for many investors to passively invest through index funds, mostly in stocks. The reasoning is simple - the market always "comes back" if one can hold on. That might remain the case, but it might not - at least in a timeframe that matters for our investment lifespans. Japan is a great example of a modern economy rocked by massive underlying changes that resulted in an economy and a stock market that has still never recovered after 30 years. Another popular investment strategy for reconsideration is common with professional investors. It is called risk-parity and was pioneered by Ray Dalio. Basically, it counts on the tendency in recent decades for US Treasury bonds to go up when stocks go down. Therefore, the strategy takes on an extra-large allocation of stocks and matches it with an even bigger amount of Treasury bonds (using leverage). This has worked great for a long time producing the panacea, outsized returns with less volatility. But - what if bonds and stocks go down together? They have many times in the past.


Green are the periods when stocks and bonds were correlated, moving together (risk-parity would not have worked then).


The Japanese market is trading still at half the highs from 3 decades ago.


5. “Market timing” is impossible – but managing exposure to risk is both logical and possible. This one is correct in principle, no matter how good one is at spotting changes in trends, it is very hard to do it consistently. Even so, my opinion is that it is worth the peace of mind to do at least a decent job at market timing. There is real value, both emotionally and mathematically, in not investing too much at the top of market cycles and avoiding some of the pain of bear markets. In fact, the second part, "managing exposure to risk is both logical and possible", is maybe the most important aspect of investing.

6. Investing is not a competition. There are no prizes for winning but there are severe penalties for losing. This one I have no issue with and makes more sense now than ever. There are some very poor outcomes possible if the virus cannot be tamed. The Spanish Flu returned in a second wave that dwarfed the first. If that happens this time (whether it is inevitable or facilitated by our own choices), the resulting devastation to people's lives and the economy is likely to be staggering. Unfortunately, the odds of multiple waves as we try to get back to some version of normal is rather high. Therefore, I prefer to be cautious in taking on more investment risk since the disappointment by not winning the investment competition does not compare to the pain of losing. And the final axiom, I think is very timely and does not require any reconsidering.

7. Investment is about discipline and patience. Lacking either one can be destructive to your investment goals.

Disclosures


This blog article nor my advisory entity is not making any recommendations, only pointing out interesting strategies for consideration. Investors should do their own research and consult their advisor before making any investment decisions.


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