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Pacific Capital Associates

Financial Advisors in San Diego, CA

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January 17, 2019 By PCA

Trends can change fast in financial markets (so don’t get caught up in the recent past)

January 17, 2019

Excerpted from a letter sent to clients on January 16, 2019

Our last letter discussed how US stocks had diverged from international stocks by continuing upwards as the rest of the world drifted downward during the middle part of 2018. US stocks went on to decline sharply after that, ending up with a peak-to-trough decline of almost 20% in just 3 months. This closed much of the gap with international stocks, which fell less than US stocks over that period:

Source: stockcharts.com

This sudden convergence shows how quickly things can turn in financial markets. And it’s not the only recent instance:

  • Despite the beginning of a politically turbulent time with the 2016 election of President Trump, 2017 was one of the least volatile years for the stock market since the 1960s. But the smooth ride ended abruptly last January, and 2018 as a whole saw volatility spike back up to the highest level since the financial crisis. (1)
  • Similarly, only 1% of major asset classes had negative returns in 2017 — an all-time low. In 2018, the pendulum swung to an all-time high as 90% of asset classes had negative returns. (2)
  • Most recently: after the steep decline in Q4, which bordered on outright panic at the end, global stock markets have been off to a strong start so far in 2019.(3)

It all goes to show that things can change fast in financial markets. Yet it’s a natural tendency for people to assume that whatever has been happening in the markets will keep on happening for the foreseeable future. This often has investors looking in the rearview mirror, choosing the investments that have recently done well and shunning what hasn’t.

In reality, trends often surprise investors by suddenly and unpredictably reversing themselves. The end result for backward-looking investors is to have bought high and sold low, leading to poor long-term returns and a higher chance of permanent loss. This is why it’s important to focus on the long-term value of what you are investing in, and to avoid getting caught up in what’s happened in the recent past.

It’s also important to be in a portfolio that aligns well with your tolerance for volatility. If you are too exposed to market volatility, selloffs like we saw in 2018 (which are an unavoidable part of the process) can be unbearable. But avoiding volatility too much can also be a problem, as it limits investment options and reduces likely long-term returns.

To get technical for a minute: we view “volatility” as being different from “risk.” Volatility is just how much investments tend to fluctuate in value over shorter periods. Risk, to us, is the chance of permanently losing money. The primary cause of investment risk is buying overpriced assets, which we try to avoid. But volatility is an inevitable aspect of markets, even with reasonably-priced investments, and we are ok with volatility to the extent you are comfortable with it as well.

In any case — we have some good tools to help dial in where you are on the volatility-vs-return spectrum, so if you’d ever like to review that, please let us know.

As to what lies ahead: short-term economic and political forecasts are a crapshoot, especially when it comes to translating them into market outcomes. We know that the global economy is still growing, albeit it at a slower pace than previously, but we don’t know when or if the many risks making the headlines will cause that to change. (Nobody else knows, either, despite frequent claims to the contrary).

We have a lot more clarity on valuations, which are the best predictor of long-term returns and risk. Much of the global stock market is reasonably priced at this point, and some of it is downright cheap. (The US market is still expensive, but even that is a better value than it was a year ago). The opportunities are out there for those willing to ignore the noise and stick to the long-term plan.

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Pacific Capital Associates, Inc. is a Registered Investment Adviser. Advisory services are only offered to clients or prospective clients where Pacific Capital Associates, Inc. and its representatives are properly licensed or exempt from licensure. This website is solely for informational purposes. No advice may be rendered by Pacific Capital Associates, Inc. unless a client service agreement is in place.

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