The Bludgeoning

In case anyone wants to know, it took a lot of work – but I have tracked down every license plate from the fleet of trucks full of black swans which have been hitting us repeatedly this year.

And good news at all? Sure. Plenty. But no one believes it is real.

I can admit to you that this quarter I have seen more double-digit down openings over minor crimps in earnings reports that I recall seeing in my life. One cannot be fooled by this action. It makes my skin crawl to watch a guidance report be released with a headline time-stamp of say, 4:11 and by 4:12 the stock of XYZ is down 22%.

Now, seriously, call it what you will but these are not human trading actions. Algo’s are now running through headlines and then running stops in seconds – moving markets, causing confusion and bringing out the emotional beast the next morning.

It’s kind of like the mark-to-market plague during ’08/’09 which unnecessarily chewed up so many bank balance sheets. This time around, mark my words, the Feds need to step in and understand what high-speed trading is doing to the average investor.

OK–that is now off my chest.

The 4 Signs of a Bottom

I have only sent this out two previous times, the tech lows back in ’03 and early ’09 when the end of the world had arrived. It is somewhat designed to make you laugh but it also has some serious hint of emotional reaction error as well.

So here are the 4 stages of fear that generally are attached to a low in the markets during corrections:

Stage 1: Where is my screwdriver? This is that feeling that begins to seep into your mind as you look at the news reel, get blinded by the devastating headlines and then you recall that your windows in your office do indeed open – if you have a screwdriver.

Stage 2: How the hell did it get there? This is when you finally are pushed to find the screwdriver, usually after you have just heard more of the never-ending terrible news streaming off your screen. Screwdriver in hand, you cannot believe how quickly the first three screws came out of that window frame holding it closed.

Stage 3: Damn it is cold out here. This is the stage where you find yourself grasping at the concrete edge of the ledge with your fingers, calculating in your mind how many dollars your account is down today. You say to yourself, “geez, at this pace, it will only take another 14 months to be at zero”, as you begin to realize just how cold it is in the winter – outside – on the ledge…..looking all the way down to your carport 12 feet below.

Stage 4: The world really is ending. They were right. You close your eyes and relive all those headlines, all the guys who said Black Swans were real, all the guys who said “they knew the top was in when….”…then, just as you feel yourself leaning forward, sure to crash onto your lawn in moments, you think of one more smart move. One more idea that is sure to cause you to turn the corner.

You Decide to be a Market Timer

Many feel it, bearish sentiment has soared. We have fewer bullish investors now in all the polls than we had at the last two bear market lows.

The experts selling you that fear are clear: “the Bear is here, get out of the market.”

The perils of market timing grasp everyone during these times. Hey I can just sell now and get back in lower. That will not happen.

I can miss all the carnage and then just buy when the coast is clear. Hint: the coast only looks clear at higher prices after a usually sizable rally “that should not happen at all.”

I repeat: Beware the perils of market timing – I cannot possibly stress this enough…and there is a ton of history that helps on this if you need it.

Any time the market experiences sudden, sharp selling pressures, like we’ve seen over the last few weeks, two things almost always happen: (1) bearish, ‘sell everything’ headlines and stories appear like crazy; and, (2) investors undergo the behavioral process of strongly considering selling their stocks (or, worse, they actually do it).

Don’t get me wrong – I want to take the plunge each time I see a rally fail and more stops get run in the market. I know exactly what you are feeling. Thankfully, we came into this after many notes suggesting we be patient and keep cash.

It’s understandable why these reactions hang around downside volatility like pests. The media knows it’s an easy road to viewership and the crowd turns to the “fight or flight” survival instincts – often without ever really knowing it.

Most just think: I want (and in some cases, need) to take action to stop the bleeding and “protect” myself.

Every single low is set when that last person leaves. It is said market lows witness empty trains leaving the station while market tops have cars loaded to the gills going off the cliff.

And yes, I know – hearing all that right now after these last 6 weeks is enough to make you angry. I feel the same – which means its working. Emotions are tugging at us, fooling us into believing something we cannot see – fear.

By the way, have you ever noticed that in a move to the upside – at the same pace and distance as downside moves – the term “volatility” is never used to describe it. Hmmmm.

Back to the Point

The moment an investor capitulates is the moment that investor becomes a ‘market timer.’ And what has history taught us about even the very ‘best’ market timers?

They will get it wrong more often than they will get it right.

So, why do investors choose this path?

It’s been stated often, but here goes:

Our emotions and brains are electrically charged to abhor losses twice as much as we rejoice in gains and that emotional imbalance often gets the better of us. We fool ourselves into thinking the best way to prevent more losses and remove uncertainty is to sell. History shows us this is one of the great jokes of investing in stocks.

Why? History once again proves that is almost always means we will be out of the market for the gains that will likely follow.

Here is the kicker: NO ONE can ever know with certainty when the market will rise or fall.

However, the crowd feels a decision to liquidate assets under the presumption that they’ll be able to reinvest again once stocks resume their rise. But, this mindset is flawed.

History proves otherwise – repeatedly – year after year, correction after correction.

The Fallacy of Market Timing, In Numbers

Long-time readers have heard me reference this often in notes before. As much as it feels good to embark on the fantasy that we can get this done with no pain, the data, history and numbers prove this dreadfully wrong.

In a study conducted by DalBar, covering a period from 1995-2014, the following data show the annualized returns by asset class – relative to the average investor:

Stocks: +9.9%
Bonds: +6.2%
Int’l Stocks: +5.0%
The Average Investor: +2.5%
Inflation: 2.3%

The primary issue the investor crowd faced?

You guessed it – market timing. Under the fallacy of “selling what is not working and buying what is working”, investors were switching in and out of funds at inopportune times.

After two bear markets in the last 15 years, it is easy to fall prey. I know. But as Dalbar shows, the process actually hurts investors. And not by a small margin.

Missing Up Days By Fearing Down Days

Again, I preface this with the understanding that it is a hard emotion to fight – fear. It paints the future dark black and is very hard to see around.

But being out of the market on just the 10 best days can kill long-term compounding. Its why you either go into a correction with cash – and are prepared to use it. Or you ride it out for the long-term…which, as noted above, is the only way to obtain long-term equity returns.

Data show that using returns of the S&P 500 from January 3, 1995 – December 31, 2014, $10,000 invested would have grown to approximately $65,500 (+9.9% annualized).

But, here’s what happens to your $10,000 investment when you start missing some of the upside:

Missed the 10 best days: $32,665 (+6.1% annualized return)
Missed the 20 best days: $20,354 (+3.62%)
Missed the 30 best days: $13,446 (+1.49%)

And, it turns negative from there.

Some investors might say, yes but what about being out of the market on the worst 10 days? That would also produce a higher total return, however getting that decision right probably means sacrificing most or all of the good days you need to produce a higher return – six of the 10 best days occurred within two weeks of the worst 10 days. It’s arguably much easier to participate in the good days than to avoid the worst days – the stock market rises a lot more than it falls.

Therein lies the terrible truth:

In order to realize long-term annualized growth rates, you have to stick with stocks when it feels ugly – like now – through the good times and the bad.

As we have stated often before: Investors assume risk in order to obtain long-term reward. Without risk, there is no reward. Believing otherwise is a fantasy.

Bottom Line for Investors

Plan first. Set standards. We have repeated this often. Cash is there for your short-term goals/needs. For long-term wealth building foundations, one must be able to take the good with the bad in order to get the long-term returns noted.

Blind bullishness is not the intended point here.

But the reality is this: For most investors with a good plan and advisor, long-term returns offered by equities are what is required to your financial objectives throughout your lifetime….right?