Over the years, during times of market turbulence, you have heard us say “stay the course” or “don’t make short-term trades with long-term money”. Following a disappointing first half of the year and a particularly brutal June, markets sharply reversed course in July. Proving yet again that timing the market is nearly impossible. Underperforming asset classes often surge surprisingly, just when we’re most convinced they never will. Broad U.S. stock indexes ended July with their best monthly returns since 2020—up over 9% for the S&P 500, while the tech-heavy Nasdaq Composite surged 12%.

Market Pricing: Compared to What?
Why the dramatic turnabout this July, even as national and global headlines remain relatively bleak? Efficient market theory would suggest, it’s not whether the news is good or bad, but whether it’s better or worse than what we’ve been collectively bracing for. As The Wall Street Journal senior columnist James Mackintosh wrote:

“The drumbeat of gloom this year drove down prices, but also meant that even-worse news was required to drive them down more. When everything looks grim, the slightest break in the clouds looks like a new day.”

Of course, even as the financial press announced the strong monthly returns, there have been plenty of pundits pointing out how fleeting any “recovery” might be. After all, most of the same challenges we’ve been facing all year remain alive and unwell, which makes it easy for forecasters to convincingly call for copious doom and gloom ahead.

They may even be correct. But once again, we caution against betting on it either way.

What Does the Data Say?
If expert forecasts were useful, we should see evidence that trading on them can improve your portfolio returns. Instead, a recent analysis by Morningstar’s John Rekenthaler reinforces existing data suggesting just the opposite is true.

Rekenthaler compared returns across five asset allocation fund categories for the 10 years ending December 2021. Four of the five fund categories were strategic stock/bond funds with a static equity exposure of between 15% to 85%. So, for example, funds with 85% equity exposure kept their 85% exposure across the entire decade, and so on.

The fifth fund category was for tactical asset allocation funds with the freedom to shape-shift their equity exposure in response to market news. “Tactical investing” is a fancy name for market-timing.

If anyone could stage a successful market-timing campaign, it should be professional fund managers and their legions of high-end market analysts. Instead, for the decade ending 2021, the tactical fund category did outperform asset allocation funds that were mostly invested in fixed income (with lower-expected returns). But they significantly underperformed fund categories mostly invested in equities.

Tactical funds also had a nasty habit of disappearing entirely, which probably prevented their worst returns from even showing up in the results (even though real people lost real money in them). Survivorship rates among strategic funds were between 66%–74%, whereas the tactical funds only survived about 53% of the time.

Rekenthaler also looked at whether investors could have done well by identifying the few “winning” tactical funds ahead of time. He demonstrated that the funds’ relative rankings were so random from one year to the next, there was no way to do that. If anything, past outperformance suggested slightly worse returns moving forward.

Stranger Things
So, are we predicting a happily-ever-after for 2022? Hardly. Then again, you never know; stranger things have happened.

Instead, because we don’t know, we diversify. And we wait. Markets have been rewarding patient and disciplined investors through the decades, we intend to continue doing the same. Let us know if we can help you manage an investment portfolio ideally structured to sustain you, your family, and your wealth through the perpetual uncertainty that lies ahead.

There’s been a lot of talk about recessions lately: Whether one is near, far, or perhaps already here. Whether we can or should try to avoid it. What it even means to be in a recession, and how it’s related to current market turmoil.

To put market and recessionary concerns in perspective, it might help to describe six ways a recession resembles a bad mood. There are some intriguing similarities!

1. 1. There Is No Precise Definition.
2. We all know what a bad mood feels like. But there is no clear definition for a nebulous mix of real and perceived setbacks, and how they’re going to affect us.

Likewise, there is no single measure to tell us exactly when a recession is underway or when it’s over. Instead, recessions can trigger, and/or be triggered by a number of interconnected economic signals. These usually include a declining Gross Domestic Product (GDP), along with rising unemployment, sinking consumer confidence, gloomy retail forecasts, disappointing corporate balance sheets, a bond yield curve inversion, stock market declines, and similar combinations of objective and subjective events.

In the U.S., the National Bureau of Economic Research (NBER) defines a recession as follows (emphasis ours):

“A recession is a significant decline in economic activity that is spread across the economy and that lasts for more than a few months.”

Rather vague, isn’t it? That’s intentionally done. Similarly, the World Bank Group has stated, “Despite the interest in global recessions, the term does not have a widely accepted definition.”

2. You Usually Can’t Spot One Except in Hindsight.

How do you know when you’re in a bad mood? Often, you don’t, until you’re looking back at it.

Recessions are similar. Since a widespread downturn must linger for a while before it even qualifies as a recession, the NBER only declares one after it’s underway. For example, in July 2020, the NBER announced we’d been in a recession for two months between February April 2020. This was triggered, of course, by the abrupt arrival of the global pandemic. It was the shortest U.S. recession to date, and already over by the time we officially acknowledged it.

3. Sometimes, We Get Stuck for a While.

Hopefully, your bad moods come and go, resulting in more good times than bad. But sometimes, one misfortune feeds another until you feel gridlocked. It may take a while before improved conditions, a more upbeat attitude, or a blend of both help you move forward.

Similarly, recessions can become a self-fulfilling prophecy. As Nobel Laureate and Yale economist Robert Shiller describes, “The fear can lead to the actuality,” in which economic conditions might feed inflation, which inverts the bond yield curve, which signals a recession, which shakes corporate and consumer confidence, which leads to unfortunate reactions that further aggravate the challenges. And so on. When this occurs, a recession and its related financial fallout may last longer than the underlying economics alone might suggest.

4. They’re Inevitable.

It’s never fun to be in a bad mood, but we can all agree they’re part of life. It would be unhealthy, exhausting even, if we were endlessly giddy every minute of every day.

Similarly, nobody celebrates a recession. But it helps to recognize they aren’t aberrations; they are part of natural economic cycles. Recessions can sometimes help rein in runaway spending, earning, and pricing for companies, consumers, and creditors alike.

For example, in our current climate, we may enter into a recession (or already be in one) as a byproduct of the interest rate increases, aimed at warding off rising inflation, amidst the backdrop of lingering supply side issues and global economic sanctions against Russia. If we can avoid a recession, all the better. But if it’s going to take a modest one to reduce inflation, it may be the preferred, if challenging choice at this time.

5. Experience Helps.

When we’re youngsters, we have little perspective to help us realize we won’t be miserable forever just because we’re unhappy in the moment. As we mature, we learn to temper our moods, and seek support if we do get stuck in a rut.

The same can be said about recessions, and similar challenges. It’s been more than a decade since the Great Recession; and more than 40 years since the U.S. last experienced steep inflation. As such, many investors have had little first-hand experience managing such turbulent times.

It may help to acknowledge we’ve been here before. The U.S. has endured nearly three dozen distinct recessions dating back to the 1850s, with an average length of 17 months. Some were considerably longer. Every recession eventually ends, with economies and markets thriving thereafter. Dimensional Fund Advisors research team shows us, one-, three- and five-year average cumulative returns after significant U.S. stock market declines dating back to July 1926 have all been positive, rewarding investors who placed their faith in future expected returns. Since markets are ultimately driven by the underlying growth in global commerce, we can expect similar aggregate performance moving forward in domestic and international markets alike. Consider these words of wisdom from one of the most experienced investors of all, Warren Buffett,:

“Periodic setbacks will occur, yes, but investors and business managers are in a game that is heavily stacked in their favor. … Since the basic game is so favorable, I believe it’s a terrible mistake to try to dance in and out of it based upon the ebb and flow of business activity. The risks of being out of the game are huge compared to the risks of being in it.”

6. You Can’t Change Others, But You Can Change Yourself.

When you’re in a funk, it doesn’t matter whether it’s due to one or many unfortunate events, or “just because.” There’s ultimately only one person who can change your mood: yourself.

The same is true for your response to recessions, bear markets, and other external events standing between you and your financial wellbeing. Life is filled with causes and effects over which we have no control, especially with respect to our investments. And yet, there are many small, but mighty acts we can take to contribute to the positive outcomes we wish to see in our homes, our nation, and the world And, we can invest wisely. This means taking charge of your personal wealth by focusing on the drivers you can control, and ignoring the greater forces you can’t. For example:

• We can’t avoid recessions. But we can channel our inner Warren Buffett to look past today’s risks, and retain an appropriate amount of market exposure in pursuit of our long-term financial goals.
• We can’t avoid bear markets. But we can avoid generating unnecessary losses by panicking and selling low.
• We can’t avoid inflation. But we can establish a thoughtful budget to track our income and spending, with a plan in place for making adjustments as warranted.

As always, we’re here to help. How can we be of service to you and your family? Don’t hesitate to be in touch.

For investors, it can be easy to feel overwhelmed by the relentless stream of news about markets. Even if you are an experienced investor, you can hardly be blamed for feeling fear, when you are hearing the constant drumbeat of data and headlines that are designed to evoke an emotional response in you. The year 2022 has been a challenging one, whether you’re invested in bonds or global stocks. This article focuses on 9 considerations to help you navigate today’s volatile markets.

1. 1. Don’t panic (or pretend not to). It’s easy to believe you’re immune from panic when the financial sun is shining, but it’s hard to avoid succumbing to it during a crisis. If you’re entertaining excuses to bail out during a steep or sustained market downturn, remember: It’s highly likely your emotions are doing the talking. Even if you only pretend to be calm, that’s fine, as long as it prevents you from acting on your fears.

“We’d never buy a shirt for full price then be O.K. returning it in exchange for the sale price. ‘Scary’ markets convince people this unequal exchange makes sense.” – Carl Richards, Behavior Gap

2. Redirect your energy. No matter how logical it may be to sit on your hands during market downturns, your “fight or flight” instincts can trick you into acting anyway. Fortunately, there are productive moves you \ can make instead – such as the nine actions laid out here – to satisfy the itch to act without overhauling your investments at potentially the worst possible time.

“My advice to a prospective active do-it-yourself investor is to learn to golf. You’ll get a little exercise, some fresh air and time with your friends. Sure, green fees can be steep, but not as steep as the hit your portfolio will take if you become an active do-it-yourself investor.” – Terrance Odean, behavioral finance professor

3. Remember the evidence. One way to ignore your self-doubts during market crises is to heed what decades of practical and academic evidence have taught us about investing: Capital markets’ long-term trajectories have been upward. Thus, if you sell when markets are down, you’re far more likely to lock in permanent losses than come out ahead.

“Do the math. Expect catastrophes. Whatever happens, stay the course.” – William Bernstein, MD, PhD, financial theorist and neurologist

4. Manage your exposure to breaking news. There’s a difference between following current events versus fixating on them. In today’s multitasking, multimedia world, it’s easier than ever to be inundated by late-breaking news. When you become mired in the minutiae, it’s hard to retain your long-term perspective.

“Choosing what to ignore – turning off constant market updates, tuning out pundits purveying the latest Armageddon – is critical to maintaining a long-term focus.” – Jason Zweig, The Wall Street Journal

5. Revisit your carefully crafted investment plans (or make some). Even if you yearn to “follow your gut” during a financial crisis, remember: You promised yourself you wouldn’t do that. When did you promise? When you planned your personalized investment portfolio, carefully allocated to various sources of expected returns, globally diversified to dampen the risks involved, and sensibly executed with low-cost funds managed with a long-term perspective. What if you’ve not yet made these sorts of plans or established this kind of portfolio? Then these are actions we encourage you to take now.

“Thus, the prudent strategy for investors is to act like a postage stamp. The lowly postage stamp does only one thing, but it does it exceedingly well – it adheres to its letter until it reaches its destination. Similarly, investors should adhere to their investment plan – asset allocation.” – Larry Swedroe, financial author

6. Reconsider your risk tolerance (but don’t act on it just yet). When you craft a personalized investment portfolio, you also commit to accepting a measure of market risk in exchange for those expected market returns. Unfortunately, during quiet times, it’s easy to overestimate how much risk you can stomach. If you discover you’re miserable during even modest market declines, you may need to re-think your investment plans. Start planning for prudent portfolio adjustments, preferably working with an objective advisor to help you implement them judiciously over time.

“Our aversion to leverage has dampened our returns over the years. But Charlie [Munger] and I sleep well. Both of us believe it is insane to risk what you have and need in order to obtain what you don’t need.” – Warren Buffett, Berkshire Hathaway

7. Double down on your risk exposure – if you’re able. If, on the other hand, you’ve got nerves of steel, market downturns can be opportunities to buy more of the depressed (low-price) holdings that fit into your investment plans. You can do this with new money, or by rebalancing what you’ve got (selling appreciated assets to buy the underdogs). This is not for the timid. You’re buying holdings other investors are selling. But if can do this and hold tight, you’re especially well-positioned to make the most of the expected recovery.

“Pick your risk exposure, and then diversify like crazy” – Eugene Fama, Nobel laureate economist

8. Tax-loss harvest. Depending on market conditions and your own circumstances, you may be able to use tax-loss harvesting during market downturns. A successful tax-loss harvest lowers your tax bill without substantially altering or impacting your long-term investment outcomes. This action is not without its tricks and traps, however, so it’s best done with help from a financial professional who is well-versed in navigating the challenges involved.

“In investing, you get what you don’t pay for.” – John C. Bogle, Vanguard founder

9. Talk to us. We didn’t know when. We still don’t know how severe it will be, or how long it will last. But we do know markets inevitably tank now and then; we also fully expect they’ll eventually recover and continue upward. Since there’s never a bad time to receive good advice, we hope you’ll be in touch if we can help.

“In the old legend the wise men finally boiled down the history of mortal affairs into the single phrase, ‘This too will pass.’” – Benjamin Graham, economist, “father of value investing”

In recent columns we have explored interest rates, and inflation – now we come to the heart of the matter: When interest rates, inflation, or both are on the rise, what’s an investor to do?

Let’s start with the big picture. We remain committed to the same core principles we use to help people invest across time and through various market conditions. These include:

• Building and maintaining personalized investment portfolios of stocks, bonds, and cash
• Minimizing exposure to concentrated investment risks through global diversification
• Low cost, tax efficient investments
• Long-term focus

If anything, adhering to these timeless tenets becomes even more important during periods of increased economic stress, market volatility, and geopolitical uncertainty.

Future Uncertainty
With so much going on, there’s been no lack of analyses of what to expect across various markets, and what investment actions you should take based on these forecasts.

The trouble is, it’s as difficult as ever to predict the future. No one can accurately predict exactly how Putin’s war is going to play out or the future level of inflation – let alone how these factors will converge with myriad others to drive future market pricing.

Moreover, the media plays an outsized role in the content that is published, and it often targets human emotion. Investors who are tempted to act on these media messages should remember the media is selling entertainment, not real financial advice. “People who generate better sound bites generate better media ratings, and that is what gets people promoted in the media business” (Wharton Professor Phil Tetlock). News from the front lines may seem tremendous or trivial, awful or inspiring, or even everything at once. But avoid letting any of it heavily influence your investment portfolio; the world is just too complex for that.

Layers of Protection
Over the years, we hope we’ve communicated what NOT to do in response to current events: Across stock and bond assets alike, it remains as ill-advised as ever to chase or flee individual positions, markets, or economic cycles.

If your investment portfolio is already well-structured, you should be well-positioned to capture appropriate measures of expected investment performance over time, while defending against inflation and other risk/reward tradeoffs. It may not feel like it right now, while we’re enduring the rising risks. And unfortunately, even a best-laid plan doesn’t guarantee success. But if you weigh the odds, your best course by far is probably the one you’re already following.

Outperforming Inflation
In order to meet your longer-term financial goals, a portion of your portfolio will need to outperform inflation over the long haul. Dimensional Funds research team members Wei Dai, PhD and Mamdouh Medhat, PhD recently concluded that “simply staying invested helps outpace inflation over the long term for a wide range of asset classes.” The analysis covered 1927 to 2020, and considered a total of 23 US assets spanning bonds, stocks, industries, and equity premiums. Over this period, inflation averaged 5.5% per year in the study’s high-inflation years. While average real returns were mostly lower in years with high inflation compared to years with low inflation, all assets, except one-month T-bills had positive average real returns in high-inflation years. “Overall, outpacing inflation over the long term has been the rule rather than the exception among the assets in the study.”

• Stocks: Equities in general, and especially stock factors such as the value premium, have handily outpaced inflation over time.
• Bonds: Investing in bonds that offer the highest yield for the least amount of term, credit, and call risk is also expected to help a portfolio stay ahead of inflation over time.

Additional defenses against inflation can include: (1) using relatively realistic inflation estimates in your financial and retirement planning; and (2) delaying taking Social Security when possible, to maximize the power of the COLA (cost of living adjustments) on higher monthly payments.

United We Stand
This brings us to an end on our three-part series on inflation, interest rates, and your investments. We included a lot of information during that time, so please think of these columns as more of a conversation starter than a comprehensive guide. Most important, the decisions you make moving forward should be grounded in your own circumstances rather than general rules of thumb. For that, the best way to move forward is together. Please be in touch if we can assist.