The Test

October 1st was our 15th birthday. Back in 1999, an intrepid little band started a new company with a handful of good clients, a good team of people and a wish and a prayer. We walked right into the 2000-2002 tech bust, a very bad market and a severe challenge for our new business. Some beginner’s luck we had! Geez.

Fifteen years and two bear markets later, we were just enjoying our birthday and appreciating how much our clients have helped us grow over this challenging decade-and-a-half. But we could not help noticing that things in the world were not good, and markets had become jittery by the end of September. We had a bad September and the first negative quarter in a little while. Nothing serious, but…

The Test

The Test

Then, the real test began. Here we are, mid-October, and the S&P 500 is down over 5% in two weeks. On October 15th, equities dropped over 3% during the day, but recovered to be down by only about 1%. Volatility is back. After several years of low volatility and good equity returns, we are now reminded that equities are risky and sometimes fall in price suddenly and unexpectedly. This is actually pretty normal behavior for equity markets, but we may have been lulled into a little complacency by the recent tranquil past.

Meanwhile, we have had yet another bond rally this year, capped by the 10-year treasury yield falling below 2%! Remember, it started the year over 3%. And remember that people have been worried about potentially rising interest rates, but we see that maintaining the bond allocation as a risk reducer, “an anchor to windward,” has once again helped a lot as equities have faltered. The fact is, we are likely to continue to be surprised quarter-to-quarter and year-to-year. You just never know what is coming next…you really don’t.

Once again, the market tests our mettle. Are we standing on solid ground, well-diversified with the right amount of risk (e.g., % equity) in our portfolios? Do we understand that we can achieve our long-term goals despite significant short-term setbacks? Are we well prepared to resist the temptation to give way to fear, as we face a risky and uncertain market?

Or, like far too many retail investors, did we get greedy and increase risk in good markets, only to be caught by a sudden downturn? And now the next step, sadly, is to sell after having losses, just in time to watch the market recover? See the DALBAR study below:

 

DALBAR Study

They update this chart every year, but the picture never changes. This pattern of emotional buying and selling sabotages portfolio returns for the majority of retail investors, and the poor results they achieve stand in stark contrast to the good returns provided by market benchmarks alone, never mind well-constructed portfolios.

So what’s wrong, anyway?

Well, a lot is wrong. We have discussed many of these issues for a long time, and we have always emphasized that bad news in the economy and the world does not necessarily translate into bad equity returns. Let us start by reiterating that message loud and clear: We do not believe you should try to outguess the markets. Just because things are going wrong does not mean that the next step for equities is down. The next surprise might be a good one — you never know. The market already knows about the bad news; you are too late to get ahead of it.

I think we can summarize the bad news as falling into three general categories:

1.  World events

2.  The economy

3.  Ebola

We do not need to give you a lot of detail here; you can see it all in the news. But let us briefly summarize:

— The U.S. economy continues to limp along as the cleanest dirty shirt in the hamper. Weak growth, poor results in creating enough good jobs for Americans, continued zero interest rates for some time to come. But Europe is worse, and China may be even worse than Europe. We have to wait and see.

— Ebola has arrived in the U.S. and has started to spread. Not many people so far, but our medical professionals and government appear to be fumbling and making mistakes. I have no idea what is next. Everyone is worried, and rightly so.

Perhaps most importantly, many consider that our foreign policy is failing. People from every part of the political spectrum are harshly critical of our policy in the Middle East in particular, where our very modest air campaign is pleasing no one. This morning, I listened to an opponent of any military action discuss why the air campaign is far too little to be effective at all, but it is more than he supports and he would recommend pulling out completely. But, if we were trying to be effective, he sees us needing to make a substantial commitment — which he opposes. But he really hates half-measures, which achieve nothing.

Unfortunately, I think we all need to be prepared to see the Islamic State making substantial further gains. The Kurds are in grave danger. Baghdad itself is now threatened. Christians are among those being massacred, and we will see more killing (and other horrors) of potentially large numbers of people of all kinds across Iraq and Syria. It seems clear the U.S. will not stop it, and no one else will without the U.S.
This may be very bad. I am sorry to say this, and I wish it weren’t so.

The only saving grace is that, while the Middle East spirals out of control, oil prices are dropping precipitously, falling below $82 today. In the past, a crisis like this could have driven oil prices very high and done serious harm to the world economy. But not this time. With increased production of oil and gas in the U.S., and also Canada and other places, supply is not a problem for consumers of energy. In fact, over time this may defund many of the terrorist forces, but for now, it is certainly good that the world economy will not be another casualty of this horrific war.

And so we are tested

Things overall may get much worse before they get better; we need to be prepared for that. We can hope for the best and remember that we really don’t know how all of this will ultimately play out. Above all, we do not know how the equity markets will respond to events as they unfold. If you have the right overall level of equities in your portfolio, and are prepared to live with short-term losses from time to time, this is no time to second-guess your strategy.

If you have had changes in circumstances, please let us know right away. The market is really not down that much. If a long-term adjustment is appropriate for you, let’s discuss that right away. For that matter, we look forward to talking to all of you. In troubled times it can be important to check in and make sure everything is as it should be.

Let’s talk soon.

 

 

Hewins Financial Advisors, LLC d/b/a Wipfli Hewins Investment Advisors, LLC (“Hewins”) is an investment advisor registered with the U.S. Securities and Exchange Commission (SEC) under the Investment Advisers Act of 1940. Hewins is a proud affiliate of Wipfli LLP. Information pertaining to Hewins’ advisory operations, services and fees is set forth in Hewins’ current Form ADV Part 2A brochure, copies of which are available upon request at no cost or at www.adviserinfo.sec.gov. The views expressed by the author are the author’s alone and do not necessarily represent the views of Hewins or its affiliates. The information contained in any third-party resource cited herein is not owned or controlled by Hewins, and Hewins does not guarantee the accuracy or reliability of any information that may be found in such resources. Links to any third-party resource are provided as a courtesy for reference only and are not intended to be, and do not act as, an endorsement by Hewins of the third party or any of its content or use of its content. The standard information provided in this blog is for general purposes only and should not be construed as, or used as a substitute for, financial, investment or other professional advice. If you have questions regarding your financial situation, you should consult your financial planner, investment advisor, attorney or other professional.
Roger Hewins
Roger Hewins

President

Roger Hewins is the President of Hewins Financial Advisors, based in North Palm Beach, FL. Roger has more than 30 years of experience in investment management, helping bring the sophisticated financial advice typically reserved for large institutional clients to everyday investors, from high-net-worth individuals and families to small businesses and retirement plans.

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The Test

time to read: 5 min