This is an ugly quarter to finish off a year when pretty much every asset class has declined. Pundits attribute the declines to a variety of reasons including an aggressive Fed, collapsing energy prices, fears of a trade war with China, and a plethora of other economic and geopolitical villains. However, in my opinion most investors are focused on far more visceral concerns: Is this the end of the post-financial meltdown run-up in equities? How deep will the correction cut? How long will it last? Should I go to cash and wait out the coming blood bath?
While market pundits have argued over what actually constitutes a pullback, correction, bear market or a recession, everyone is in agreement that recent market declines are wildly unsettling. Market declines, as painful and unsettling as they are, do not last forever, and in times like these it can often be you yourself, rather than unfavorable market conditions, that ends up being your own worst enemy.
Despite the plethora of technical and fundamental data available to support any investment decision, investing is largely a human endeavor and therefore very much susceptible to human emotions -- fear of loss being amongst the primary ones. In market conditions such as these, it is very easy to panic and give in to the urge to move to the perceived safety of cash. While doing so may provide relief in the short-term, in the long-term you will be faced with the larger problem of re-entry into the market. Market conditions, no matter how unfavorably perceived, should never diminish one’s unwavering commitment to the basic tenet’s of sticking to a long-term strategic asset allocation designed to bring about the achievement of long-term financial goals.
I’ve not come across many who want to go into cash and remain in cash forever. Although perhaps not perceived as such, going into cash with the intention of re-entering the market is the definition of “market timing,” which as savvy investors know, rarely works out well. Therefore, logically, going into cash requires the accompanying assumption that in some timeframe or some set of conditions, there will need to be a re-entry point. The problem is that no re-entry point ever feels safe.
Last December I addressed this issue in a column titled Worried About Equities? Avoid Your Single Worst Possible Mistake. As 2017 was a pretty good year for equities (e.g. the S&P 500 gained 21.83%), a major concern was when to pull out of equities to avoid the inevitable upcoming correction. In that article I stated:
“Going to cash is relatively easy, and with short-term hindsight you feel smart, or you feel early. The larger issue is reentry. When you pull out of the markets, no reentry point feels safe. Should the markets continue to rise, the fear of being whipsawed by coming back in at higher prices just before the great fall – which you predicted when exiting – is really scary. Should your exit be followed by the decline you predicted, you feel that you were right, and rarely have the comfort to reentry, as prices continue to fall. Very few nail either exit or reentry points correctly with consistency.”
This year-end we have been faced with the reverse as markets are declining and will most likely leave 2018 as the worst performing equity market since 2008. Exiting equities now for cash, at least temporarily, will feel smart should they continue to fall, but how many are comfortable trying to “catch a falling knife” by re-entering a declining market? Furthermore, should markets recover following going to cash, the fear of being “whipsawed” by buying back in at a higher price with the possibility of experiencing a second decline can be psychologically devastating. Riding out rough markets while re-balancing into under-performing asset classes is difficult, but history has proven that it is the best course of action.
Investing is a human endeavor and it takes discipline and courage to fight knee-jerk fear reactions, especially in market conditions such as the ones we are currently experiencing. While it is not unreasonable to have concerns that markets are too high or the outlook is bleak, the cost of abandoning long-term strategic asset allocation, to me, creates greater anxieties. When it comes to investing, giving in to fears, rather than the discipline of long-term investment, may be your worst enemy.
