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When Expectations and Reality Don't Agree

When Expectations and Reality Don’t Agree

        Bull market tops are messy. They can last a long time spanning 6 months to almost 2 years. We’re in that period of time now and in my experience, they can be very frustrating. Let us provide a quick update acknowledging how you might feel right now and finish with a reality check. Our intention to set expectations to better sync with current market conditions.

Special Client Update Regarding October Market Declines

        This is an update for our clients who want to know how we’re positioned now that the markets are in a steep decline. To offer a quick summary, our Net Exposure model moved to a strong negative reading on Thursday of last week (from +6 to a -15). That type of movement in our net exposure system is not at all normal and indicates much more underlying weakness in the market than most are aware of. All equity models raised cash to 25% by last Friday and we have now hit our second level of defense early this week taking our cash position for equity models even higher (nearly 40%). Blended Asset models (All Season, Foundations and Gain Keeper Annuity) were already very defensively positioned last week with less than 40% stock exposure plus short term bonds and commodities which continue to plow higher. Income models are largely in cash, floating rate funds and T-Bills - super safe. So, rest easy, we’re in very good shape in terms of our net exposure and have been playing defense since late September. Now the markets are entering the oversold territory and we’re expecting some form of bounce from these levels. Much will be learned from the nature of that rebound. Rest assured we have both hands on the wheel and are making daily adjustments as needed.

Expectation vs. Reality

        When investors feel, or expect, one thing and find that their assumptions are not playing out, we get frustrated. I’ve been there, and it stinks. We want to be right, we want to do good homework and be rewarded for our effort, knowledge and time. We want to see our wealth continue to move higher as it has done for the last 9 years. Seasoned investors know that the equity financial markets can be very rewarding, better than any other asset class as a matter of fact. But they also know that there are periods of time when returns simply stop coming, volatility rises, and our objectives need to change. Specifically, as conditions become less friendly and opportunities give way to risk of permanent loss of capital, we must become more focused on preserving wealth, rather than accumulating wealth. Thankfully, these periods tend to last about 24 - 36 months on average which is actually a relatively short period of time. But they can be devastating to your net worth if not managed appropriately. Remember, there’s nothing wrong with bear markets, It’s just the natural order of things, like the seasons of the year (All Season!) In fact, as prices move lower and reset to more attractive levels, that is when real opportunity and real value begin to emerge. We genuinely look forward to deep market corrections because we know that out of those lows, we’re going to make a ton of money. But let’s get back to where we are today. We’re carving out a long-term top in stocks with little doubt and it’s time to match up your expectations with reality.

        You might be expecting returns to continue as they have for the last 9 years. You hear that prices are at an all-time high but it seems like your investments are not moving much. You’re in good company, everyone is having the same experience including our own clients to some degree. We told all of our clients at the end of 2017, in print, on-line, in person, etc that 2018 is going to be a year of higher volatility and much less productive in terms of total returns. Remember the commentary about picking up nickels in front of a steamroller?  There is growing evidence that the last major market peak in January of this year marked the beginning of the “topping period” for the US stock market. And with the price action in October thus far, we may be carving out a more meaningful top now from a very slightly higher level.

        This is standard market action for this stage of the cycle. We are lured into believing that the bull market will continue with recent marginal new highs in various indices. And on the surface, YTD numbers are still okay for the stock market. But if we shift our gaze to the January peak and do our comparison again, you see another reality. You see very few gains, if not outright losses (since the January peak). For instance, at the end of last week, the Dow Jones Industrial Average squeaked out a marginally all-time new high. On the same day, more than 50% of the stocks in the index were trading down below their long term 200 day moving averages. This is reality. We have a thin market, represented by a couple indices, hovering at all-time highs, while the majority of their components are already trending down in price. Remember that bonds are now down between 4-11% as of last week as well. Commodities are starting to perform well but no one owns commodities (except us - wink). All said, we might begin to understand why a diversified portfolio might not generate the types of returns you have seen in the past few years.

        If we were to offer advice to everyone, right now, it would be this; Temper your expectations and adjust for a market environment that will be less rewarding for a while. Limit your efforts to make big returns, change your focus to capital preservation (as we have) and get excited about the developing opportunities to make some real returns from much more attractive levels. We are forever grateful for opportunity and truly loathe these late cycle environments when gains are a bit fictitious and hard to keep. Keep the faith, investing is the best way to increase your wealth over time. Never give up but stay diligent with your systems. “Creating wealth and defending it (like it says in our logo), requires that you look both ways when crossing the street and that process begins with a mental adjustment.

That’s it for now, just some timely mental health if you need it.


Sam Jones