If you can keep your head when all about you are losing theirs…
Rudyard Kipling, from the poem If, circa 1895
We will forever be debating the causes of the 2008 financial crisis and the government’s attempts to minimize its effects. But the worst modern bear market other than the one caused by the Great Depression had an enormous effect on investors. And the aftermath still lingers.
As anniversaries go, it’s hard to figure whether this is a good one or a bad one. (Recently, on its ten-year anniversary, I wrote about one of the lowlights of the great financial crisis; the Bernie Madoff scandal.) Today, I write about one of the highlights: The market bottom.
Exactly ten years ago, on March 9, 2009, the S & P 500 Index reached its bottom; having fallen 56.8% from its October 7, 2007 peak. Ten years on and with a more than 300% increase later, the stories of investor reactions at the time are legion. And offer a multitude of lessons for the future.
Market bottoms don’t just happen. In fact, all price movement occurs due to the activities of buyers and sellers. Prices rise when increasing numbers of buyers are more optimistic and are willing to pay higher prices than they were the day before. In turn, prices fall, sometimes precipitously, when sellers are willing to get out of positions at seemingly any price.
Benjamin Graham, Warren Buffet’s mentor, said: “In the short run, the market is a voting machine but in the long run, it is a weighing machine.” We believe markets are generally efficient and reflect rational investors weighing their views of companies’ future prospects. But there are times when the future becomes extremely uncertain. Or when investors lose their nerve because they have miscalculated their time horizon. Or may be forced to sell on account of margin calls. 2008/2009 was surely such a moment; when many investors were voting with their feet. And the tide didn’t turn until everyone who wanted or needed to sell was finished.
This is one of my favorite quotes from that era, from Larry Swedroe, Director of Research at Buckingham Strategic Wealth; author and mentor to hundreds of advisors. The stories are legion among financial advisors receiving calls and holding midnight meetings with clients trying to navigate a financial storm the likes of which many of us had never before experienced.
There were the heirs of long-time bank executives who had their entire portfolios concentrated in just a few “blue chip” bank stocks. Financial stocks were among the hardest hit by the crisis. In the spring of 2008, Bear Stearns was sold to JP Morgan at ten cents on the dollar, with funding from the Fed. Who will ever forget the collapse of venerable Lehman Brothers, founded in 1850 and bankrupt on September 15, 2008. Other financial services companies barely survived.
Countless investors holding even reasonably well-balanced portfolios of stocks and bonds panicked, put all their money in cash and CD’s and have remained there ever since.
Right around that time, I received a call – not the first such call – from a nervous-nelly client demanding that the stock allocation in her portfolio be sold and squirreled away in cash. Don’t get me wrong, we all had good reason to be nervous. Most of us had seen nothing like this before. Even though she had a well-thought-out financial plan and a written investment policy statement, I acceded to her request. (Not sure if I would do that today.)
But…I insisted that she come into the office within a couple of weeks and review her plan. After several hours of number crunching – and teeth gnashing – in the financial planning software in which her plan resides, she agreed to a number of the salient points I calmly pointed out. First, it would be impossible for her to achieve her retirement hopes and dreams for the ensuing thirty years on just the meager returns that cash and CD’s were going to provide. Second, she had already withstood what seemed likely to be a good deal of the carnage. Third, governments around the world – after some fits and starts – were deploying tools developed since the Great Depression that seemed to have a reasonable chance of avoiding another one, even if it might take a while. And finally, there are no green lights to tell you when to get back in.
So, within a month or so of (what we didn’t know then was) the market bottom we got her reinvested in what we believed was an appropriate asset allocation consistent with her re-asserted risk tolerance and she has been able to take advantage of the ensuing ten-year bull market that no one knew was just beginning.
Holding on during nausea inducing times takes courage and commitment to your plan and strategy in the face of never-ending proclamations in the news media that the world is going to end. There is always something to worry about. And sometimes those things come to pass. But most of the time, having a well-thought-out plan and the discipline to stick to it will serve you well.
This lesson isn’t about buying at the bottom and selling at the top. That is simply impossible. But more about conjuring a way to tease out a likelihood of success in an environment that simply wasn’t designed for ad hoc decision making.
This has been one of the longest – if not the strongest – bull markets in history. But thankfully, unlike the tech stock and real estate bubbles, people have not quit their day jobs in droves to start day-trading and flipping houses. While much of the rally has been led by the FAANG stocks, investors, by and large, have taken a more sanguine and less speculative approach to their portfolios; as reflected in the substantial increase in passive, index type investing during the last decade.
Maintaining a strategic asset allocation – say a simple 60% stocks/40% bonds – can be an effective investment strategy. A strategic asset allocation targets both an appropriate amount of risk and the required rate of return an investor might need to achieve her goals. But if you did manage to maintain your 60/40 portfolio at the market bottom and haven’t touched it, it would now be an 85/15 portfolio with considerably more risk. Rebalancing along the way would have been a more preferable form of discipline. Taking profits to fund your ongoing spending or to fill in asset classes which have underperformed, such as international and value stocks. But if you haven’t done so, now is the time to take a good, hard look.
It is also crucial to understand that following a decade of above average returns the concept of “reversion to the mean” suggests we are likely to experience below average returns for the next decade. So be prepared for that.