Market Correction Soothsaying. Do you need to listen?

It was only a few months back we learned of the over-hyped story about a boat stuck in a ditch owned by Evergreen, the Ever Given. An important ditch nonetheless - the Suez Canal. Now another EVER-something has hit headlines. Mind you anything that isn’t about Covid is probably viewed as a welcome distraction.

This latest Ever-something story sees financial commentators and the media comparing this Chinese property developer’s woes to a Lehman Brothers or Bear Stearns of GFC times. Sensational claims and fear always sells well with the punters. We call them Soothsayers. Many have YouTube sites, work in big banks and even cable TV channels!

Did you even hear of Evergrande before this? Or, that property makes up around 7% of Chinese economic activity and indirectly some 20%+ (counting its goods and services providers)? Well, this and Evergrande’s gargantuan size has all those that feed off what we call ‘soothsaying’ very excited.

The question for us as investors is does it really matter if their claims are right, who it is, or why it happened? And if it does cause the next correction is that crucial to you? Will this, or stories and events just like it, cause you to not reach your own financial goals?

The answer is only if you let it. Bad events will always happen. But investing in a quality mixed portfolio of assets across many professional managers, along with the acceptance of volatility (and even unpredictable events like Evergrande) is actually part of a good process. Trying to avoid events via prediction, no matter who is saying it, is highly dangerous. A good process will produce success over time for the savvy investor.

Take a moment to study the graph. It is an update of one we published last year. We have added one extra plot - the biggest fall within each given year (the red dot). What can you observe about the bars above the line, below the line and the red dots in relation to them?

The first observation is that there are more positive returns than negative ones. The second being that those increases are bigger than the decreases. This means that when one does the math, over time your account balance rises, and it rises handsomely. For capitalism to function at its most basic, this outcome MUST happen, or capital would otherwise be destroyed, spelling an end to capitalism (the only system of commerce to have endured). As it has done so for many hundreds of years, we can safely utilise this premise in how we invest with great certainty.

How this benefits your hip pocket: $10,000 invested in the S&P 500 Index back in 2000 was worth over $42,000 by December 2020.

No predicting of events was required with the associated risk, effort and angst. The healthy return of circa +7.5% pa earned had 70% of this result coming from just 10 single days. Here's the thing however; miss those 10 and your funds grew to less than half that, to only $19,300. Miss the best 20 days and your account balance fell lower to $11,500. That’s less than 5% of the potential return of remaining fully invested. Missing those gains is easy to do when trying to predict things.

The third point therefore is crucial. In most years with large gains they also contained periods of sizable losses within those years (the red dots), lasting weeks and often for months. For those easily spooked with no plan or understanding, these intra-year moves can cause you to sell or buy at precisely the wrong time. Think about these numbers from the S&P 500 below as these would give the uneducated plenty of reason to exit, or time when to be where:

  • Peak-to-trough the average loss in a given calendar year from 1928 is circa -16%.
  • 53 double-digit annual falls have occurred to date.
  • The average loss was -23%. Some lasted more than 200 days (from peak to trough).
  • The market has fallen to at least -20%, 21 times. (that’s once every 4.5 years).
  • It’s also fallen -30%, 13 times. (that’s once every 7 years).

Of course, averages hide absolute peaks and troughs. For instance the market fell -50% from 2000-2002 (the dotcom bubble). It repeated that feat just 6 years later (the GFC). Yet, from 1940-1968, there wasn’t a bear market worse than -30%. Then, over the next 6 years it happened twice (the 70’s oil crisis).

Positive stats can also be just as prominent. In some years there were no corrections at all. In 34 out of the past 93 years, there was no peak-to-trough fall that reached double-digit negative levels in a calendar year period. For 7 years, there wasn’t even a -5% fall (the latest time that occurred was 2017). From 2007-2011, the average peak-to-trough fall EACH calendar year was -24%. Then from 2012-2017, it was just -8%.

What are all these statistics telling us? First, things do go ‘bump in the night’. At times they can be a virtual roller coaster ride, or as flat as a becalmed sea. All these scenarios will continue to happen too. Expect them, and importantly ensure your portfolio is built with this in mind. Not to avoid them, as that is far too risky and impossible to predict - no matter what the soothsayers say. Rather, weather the storms and even profit from their occurrences both up and down.

Second, the time periods we use to measure returns count in shaping how we respond. Be careful about this. The shorter the time period of measurement the more things will jump around (e.g. a year or less).

For each correction there is also a different reason, and for the most part, the reason doesn’t matter. At the end of the day successful investing is about mathematics and patience. Sometimes the cause or trigger is macroeconomic related. Sometimes it has to do with market fundamentals, or it might be geopolitical in nature. Sometimes investors are simply looking for an excuse to sell after experiencing large gains. Then, sometimes the downturn feels completely random.

Just because the Evergrande story will likely not morph into another Lehman or Bear Stearns, doesn’t mean it won’t impact certain investors or investments. It still might lead to some damage for the unprepared, greedy or undiversified.

The question after all this is still: Does it matter to you?

No, and here is why: First, we use multiple fund managers in client portfolios that manage their portfolios differently to one another . This means they hold scores of different stocks in different places (sometimes a few of the same) and for different lengths of time. Thus one large company failing (if it does) won’t be an issue. Two good reasons why we recommend using professional fund managers are spreading your eggs, including spreading how they each invest on your behalf – and to do so in complimentary ways. This is a big part of what your adviser does. Not to pick specific winners but blending them to create a winning team of funds for an overall outcome that you require. This is what matters, ensuring your plan delivers what you need. Never mind anyone’s else’s plans and investments.

 But what if Evergrande is a trigger to a systemic fall hitting most of my investments - what then?

 Well, if you measure your time horizon in years and decades, you’re going to be dealing with a few of these. It's all part of investing. At times, a large portion of your portfolio will seemingly pale to a low value (for a time at least). Riding these times out however really works. Those statistics mentioned earlier on showed, by hanging in there, you will do at least ok - and usually better. This same longer time horizon for assessing performance also just so happens to produce bigger positive results too.

Make time your friend. Having the right perspective on the factor of ‘time’ means a great deal if you want to be a successful investor. For those investments that get hit with volatility, they also tend to return the highest (the reward for volatility). You just need the time to weather each storm. In other words, patience. Don’t try and time being in or out or fall for the seduction of sophisticated soothsaying. None of that works.

Soothsaying actually requires 8 correct predictions for EVERY event. The emotional fear/greed-based instinct of trying to time these events means you must get many things right each and every time.

First question to get right is where is the source of the event coming from? Then when will it happen and for how long? Now you are up to question four; where to go as a result?

The final four questions to also get right are: How much should you then shift? And importantly how will markets react to the event anyway? You’d be surprised at how often the market moves entirely different to what you and the ‘experts’ expect. How low will it go? Lastly, for how long should you stay out of something before the market then changes back?

For example, at the trough of doom early last year as Covid took hold, markets had their biggest fall ever, only to be followed close on its heels by the single biggest gain.

That’s 8 questions to get right for every potential event! Here’s a less complicated and easier way:

  1. Go with the patterns of mathematics and the basic investment principles your adviser has shared with you.
  2. Take time to understand this as knowledge helps you to overcome any knee-jerk reactions. It also contributes to a better night's sleep when markets are stormy.
  3. Be patient and ride out those storms and when things get volatile.
  4. Don’t get greedy or scared either.
  5. Match your expectations to the right time-frames, and above all, stay with the plan of approach your adviser has built for you.