Back on February 2, I wrote on my subscription JubakAM.com site (and on this site https://www.jubakpicks.com/the-limits-of-st…-guide-right-now/) “I just don’t think stock market history is a very reliable guide to the present and the near-term future right now.”
And I laid out four reasons for questioning the usefulness of financial market history currently. For example, I noted that “If history is any guide, you can also make a strong case, as Wall Street money managers are busy doing right now, that a big cycle of interest rate increases from the Federal Reserve and other central banks doesn’t have to tank the stock market. Market returns in the year after the Fed begins to raise interest rates are surprisingly positive, historical data argues. Exactly how positive depends on how you slice and dice the time periods around a turn in the interest rate cycle, but history says investors aren’t looking at the end of the world.”
The key phrase I noted is, “If history is any guide.”
Rather than simply leaving you with my thoughts on the limits of financial market history’s patterns right now, I promised at the end of that post to return with some concrete suggestions on how financial markets might behave in the absence of reliable historical pattern and on how this period of unreliable history leads to new investment strategies. I wrote “When I started this post, I thought I’d merely lay out some of the reasons for thinking that financial market history might not be a reliable guide right now. Having gotten this far in the topic, though, that seems an inadequate response to the problem: If I’m right and financial history doesn’t give us much guidance, what does? And what can we expect in the next five to ten years? And what should we do as investors during that period?”
I promised that would be the topic for a post in the next day or so–which counting on my fingers says would have resulted in a post on February 3 or February 4.
I’m a little late–since today is February 11. Market volatility and some unexpected difficulties in figuring out exactly what I wanted to say have contributed to the delay.
But I wanted to get these thoughts up before I post my newest Special Report: “A New Core Portfolio for a New Market–10 picks” on JubakAM.COM. The strategy conclusions I’m putting out today certainly feed into my thinking about the nature of the new market. I’ll be working on that that Special Report over the weekend and will post it on Monday, February 14, just in time for Valentine’s Day. (Or at least Part 1 with those 10 core picks.)
Let me be upfront. My thoughts on what it means for the financial market if we’re shifting gears so radically that market history isn’t a reliable guide to market behavior are speculative. They’re based on what I’ve seen in market action recently (say, over the last 6 months), what I’ve observed of market behavior over the last 40 years of so watching financial markets, what I’ve learned in other major gear changes in the financial markets such as the Dot.com bust of 2000 and the Global Financial Crisis, and what I’ve gleaned from my reading about how paradigm shifts come about and the role of individual choice in accepting such a shift (especially in the work of Thomas Kuhn in The Nature of Scientific Revolutions (1962) and The Copernican Revolution (1957) A key insight from Kuhn: “When scientists must choose between competing theories, two men fully committed to the same list of criteria for choice may nevertheless reach different conclusions.” For this reason, Kuhn argues the criteria still are not “objective” in the usual sense of the word because individual scientists reach different conclusions with the same criteria due to valuing one criterion over another or even adding additional criteria for selfish or other subjective reasons. “I am suggesting, of course, that the criteria of choice with which I began function not as rules, which determine choice, but as values, which influence it.”).
And now let me leave the theoretical framework behind and plunge right into my observations on what a period when market history isn’t a reliable guide to future market behavior might mean for investors.
1. Widely accepted historical frameworks for financial market behavior are extremely robust. They hold on tenaciously. And it takes a lot of contrary evidence to cause one to be abandoned or significantly revised. The current historical observation that a cycle of interest rate increases from the Federal Reserve doesn’t lead to a falling stock market is supported by a significant amount of data. And, as well, it is supported by a large measure of self-interest among market participants since Wall Street has an institutional interest in investors staying invested (or, perhaps, even better, selling and then rebuying) and financial market professionals make more money if clients remain clients. Right now all the grounds for believing “this time it’s different” are based on a reading of economic conditions and a critique of the conclusions derived from the historical record. That is, in my opinion, the observation that stocks usually gain even when the Federal Reserve has begun a cycle of interest rate increases rests on the fact that most periods of inflation that lead to interest rate hikes occur because the economy is overheating. That would lead to companies showing higher growth that more than balances out the increase in interest rates. This time it’s different because we’re starting from a much weaker than usual economy and because there’s a good likelihood that this cycle of inflation isn’t the result of an over-heating economy but of factors such as under-investment at key points in critical parts of the global supply chain.
2. It is therefore not easy to displace an existing historical framework for financial markets behavior. The existing historical framework has become the default position for investors. And whatever doubts they might have about that framework explanation in the short term, they are likely to return to that position over and over again.
3. Therefore it is extremely easy (and potentially very painful) to be early on a shift in the historical framework. If the idea that growth will bail out stocks in the next cycle of interest rate increases from the Federal Reserve, remains the default position, then the default impulse for investors in the market will be to buy any dip in growth stocks created by the (erroneous) belief that this time it’s different. (This would also suggest that we’re a long way away from the recently frequently touted shift to value stocks.)
4. The period around any shift in the historical framework that guides investing behavior is likely to be characterized by higher volatility and frequent dips and rallies. The challenge to any investor is coming up with the strategy for coping with or using this volatility that fits with that investor’s desire/ability to devote time to investing, that matches a volatility strategy and an individual investor’s time horizon for reaching that goal, and that lets an individual investor sleep at night since we all have different risk tolerances. This isn’t the time for a one volatility strategy fits all approach, but it is time for each of us to recognize that our portfolios need a volatility strategy. (I’m going to build on this point in what now seems like a Part 3 to my Special Report on a new core portfolio for a new market.)
5. One of the biggest challenges of a period of higher volatility (and a period of low or negative total returns from fixed yield income assets if we do get an extended cyclical of interest rate increases from the Federal Reserve) is building a portfolio with a core that takes advantage of the higher valuations such a market is likely to award to stocks of companies with steady and predictable growth (like the 10 stocks that will go into my new core portfolio in this Special Report) and that also includes buckets that generate higher returns from that volatility and a bucket that generates predictable cash flows to an investor. If that sounds like the three bucket system I’ve laid out for retirement and other long-term goals, that’s because it is. And in Part 2 of my Special Report I’m going to integrate those buckets–with some stock and ETF picks for those buckets–with the new core portfolio for a new market.
So that’s the road map for my Special Report.
Sounds like a busy weekend.
I’ll have the first part of the report–my 10 picks for a new core portfolio–posted on Monday on JubakAM.Com. If you want to subscribe look for a 20% off email in your mailbox on Tuesday.
