There are very few hard and fast rules when it comes to markets.
Nothing works all the time.
The biggest investors in the world can go through multi-year periods of underperformance. The dumbest investors in the world can go through multi-year periods of outperformance.
These things happen because humans control the financial markets and humans can be erratic at times.
In my opinion, there are really only two constants in the markets: risk and cycles.
The risk must exist because without it there would be no reward.
And nothing is more reliable than cycles because market psychology, fundamentals, risk appetite and investor emotions are constantly changing. Strategies, asset classes and stocks go out of style, partly because the pendulum is still swinging between fear and greed, but also because the future is unknowable.
For most of the 2010s, it felt like tech stocks were untouchable. They were growing like crazy. Everyone used their products on a daily basis. The performance of many of these companies has been outstanding.
Then Covid hit and it felt like the rich were just getting richer.
The pandemic accelerated technology adoption and it looked like these companies could never lose again. They would only get bigger and more powerful.
And yet, the majority of tech giants, with the exception of Apple, have been crushed:
Trillions of dollars in market capitalization have evaporated from these stocks. Nothing fails like success in the stock market.
All it took was the highest inflation readings in 40 years and rapidly rising interest rates.
The hard part is that no one could have predicted what the cause would be. It’s easy to dive into magazine metrics like this one from 2019:
At the time, it looked like inflation was dead! The Fed kept interest rates at 0% for over 6 years and we didn’t even feel inflation in the 2010s.
All it took was a pandemic, a global supply chain crisis, and billions of dollars in government spending around the world.
But that’s the problem with cycles – predicting a regime change in advance requires being right in both timing and reasoning. No one was predicting the worst pandemic since 1918 in 2019, but that’s what changed everything.
One of the reasons cycles are so hard to predict is that people in the financial industry love to proclaim the death of things. The most famous example is The death of stocks BusinessWeek cover story in 1979.
Ironically, at the time, inflation was the stock market’s biggest problem. Inflation has been sluggish for much of this century, as were stocks in the 1970s. See how it all comes full circle?
This magazine cover didn’t exactly bottom out in the stock market since there were two major corrections in the early 1980s, but it was damn close. The next two decades would usher in one of the greatest bull markets of all time.
There is a big difference between death and dormancy.
For years, investors and pundits have predicted the death of the 60/40 portfolio:
The 60/40 portfolio has been off for over a decade. Then this year unfolded in what was one of the worst years ever for a 60/40 portfolio.
Does that mean these people were right all along and right at the start? Or do they just not understand what cyclical investment strategies look like?
Believe me, the 60/40 portfolio is not dead because it had a bad year. That’s not how it works.1
This same line of thinking has been applied to the 4% rule for portfolio withdrawals over the past few years because bond yields were so low.
Guess what?
Bond yields are now between 4 and 6%. The 4% rule is back from the dead.
Or maybe he was never dead to begin with and it’s all just cyclical.
Listen, markets change and evolve over time. Investment strategies that once worked in the past can be arbitraged once smart money discovers them. Size is the enemy of outperformance.
The point here is that no single strategy works always and forever.
Trees do not grow towards the sky. A terrible company can make a fabulous investment at the right price, while a fabulous company can make a terrible investment at the wrong price.
Investors oscillate between fear and greed, speculation and conservatism, patience and panic.
In 2021, Robinhood’s trading platform crashed because too many people were speculating on meme stocks.
In 2022, the Treasury Direct website went down because too many people were trying to buy Series I savings bonds.
Markets are always and forever cyclical. The problem is that it is fundamentally impossible to predict the timing and reasoning for the end of old cycles and the beginning of new ones.
Michael and I discuss 60/40 portfolios, the 4% rule, inflation and more in this week’s Animal Spirits video:
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Further reading:
Financial news doesn’t rhyme but it repeats itself
Here’s what I’ve read lately:
1Moreover, to proclaim that the 60/40 portfolio is dead is like saying that diversification is dead.
#markets #reliable #cycles