Reality Meets Expectation
100 years of data really only tells us one thing about stock market volatility: it is persistent.
Once it's here, it tends to hang out for a while. So as we begin another week amidst a messy global banking situation, don't eat the bait.
The empirical research does NOT reflect that the opinions of people yelling on TV are useful to improve your experience as an investor (anecdotally, consider this & this).
We don't know which direction the stock market will go. We don't know if interest rates will rise or fall. We just know that we are probably in for a ride for at least a few weeks.
The challenge that investors face is portfolio confidence. Long-time readers know that I write in broad strokes, often with clarifiers, when I talk about investments.
Future expected returns
Ceteris paribus / all else equal...
Why speak so cautiously? Because investing is an art of probabilities. We want to be careful; sometimes expectation will not meet reality. That itself should be an expectation.
Here is research from Schwab about the relationship between stocks and bonds:
Source: 12-month rolling returns from 1/30/1976 to 10/31/2022 for the Bloomberg US Aggregate Bond Index (bonds) and the S&P 500 (stocks). Indexes are unmanaged, do not incur management fees, costs and expenses and cannot be invested in directly. For illustrative purposes only. Returns assume reinvestment of interest and/or dividends and do not assume taxes. Past performance is no guarantee of future results.
The top-left are all the 1-year periods of stocks down / bonds up, and the bottom-left are all the 1-year periods for stocks down / bonds down. You'll notice a dearth of data in the bottom-left. On expectation, when stocks go down, bonds are a great buffer. We don't observe them frequently decline together. But it can happen.
We shouldn't have entered 2022 expecting that they would. But it happened.
And today in 2023, now almost two weeks into global citizens questioning faith in the banking system, investors should have some of their faith restored as reality is matching expectations: the bond market has behaved how we would expect.
Since March 8th, an index representing banks has gotten crushed. The S&P 500 is slightly negative, and the reference bond index is up 3%!
Any time volatility spikes, I think about Naomi. Like Ichiwa, our task is simple: as managers of portfolios, we should do one thing really well, and it's to be a methodical implementer of a predesigned plan.
In 2022, diversification didn't pay off as stocks and bonds went down at the same time. It's not our expectation, but it was reality. Investors must avoid reversing-course due to a crisis of confidence in their current portfolio — it's a classic recipe to destroy wealth, and can't be undone. You must have a plan you can stick with.
That's why it's important to not necessarily know the minutiae of your investments, but at least understand the basic philosophy and ideas that will deliver your future returns. They need to resonate with you, and you can't ignore this. At some point, unfortunately for all of us as we get older, there won't be a lot of future returns left to improve upon.
And as far as this week, stop thinking about what might happen to your investments in the short-term. It's likely to be volatile. That's it. Not worth forecasting anything beyond that. Instead, ensure your portfolio owns the right types of assets for what you're trying to do with your life. It should be rules-based, agnostic to your own opinions about the market and economy, and deaf to blowhard pundits (and irreverent toward companies with commercials on TV trying to sell you financial products).
If there's a benefit to the last couple weeks, it's renewed confidence in reality meeting expectations. That doesn't mean your portfolio is necessarily up, just that the expected value in having a thoughtfully designed, risk-appropriate portfolio was realized.
Bank scare. Markets spooked. Stocks down. Bonds up.
You might be disappointed, but don't be surprised.