It’s December 31st, 2019 and financial markets around the world just capped off one of the best years on record. At that time, if someone had told you we were on the cusp of one of the worst global health crises of all time – one that would all but cause the global economy to grind to a complete stop – what would you have done? From an investment standpoint, it is hard to believe any response other than “sell everything”. In the moment, it may seem like this would be the only rational response. Yet, possibly even harder to believe would be the notion that within months, global financial markets would be setting new all-time highs. Decade after decade, mankind has been through a barrage of events that seem to spell the end of the world. And while it is easy to offer the simple prescription to “avoid any and all emotional reactions to these events”, we know that is not always possible. Human beings have evolved in such a way where emotional responses are unavoidable – we are hardwired to react to certain events that trigger us. And while it is not possible to be devoid of emotion, knowing how markets have performed during and after previous calamitous periods, and more importantly having a process to take advantage of these periods, can make a tremendous impact on your financial future. In this article, we’ll take a quick look at historical events that have shaped financial markets and explain how the Osborne Partners Investment Team approaches periods when emotions are running high.
As you can see in the table, every decade has had its share of notable events – war, financial scandal, terrorist attacks, pandemics – we have nearly seen it all in recent decades. During many of these events uncertainty, fear or panic is commonplace. Several have sent financial markets reeling with it often appearing as though there would be long-lasting damage inflicted to global economies and markets. And on occasion, there has been.
Since 1930, the average bear market, which constitutes a market decline of more than 20%, (many of which were caused by events in this table) has lasted for approximately 22 months. Some are longer, like the bursting of the technology bubble in 2000 that lasted for nearly 30 months. Others, like the one we just experienced in March, which lasted only 1 month, can be very brief. But the duration is not the point – the point is that financial markets (and mankind) have repeatedly proved to be incredibly resilient. To demonstrate this, consider that the average bull market not only lasts more than twice as long as bear markets (54 months vs. 22 months) but the average return of 166% far exceeds the average bear market decline of 42%. Or consider that since 2015 there have been five instances where we have seen the S&P 500 correct by 10% or more. The average amount of time it took for the market to recover back to its previous high was only 121 days or just under four months and the total return from the start of 2015 through last year was just over 100%. More times than not, investors are surprised at the speed and strength at which markets rebound. This topic alone could be its own article, but for the sake of time the easiest way of explaining this phenomenon is that financial markets are not pricing in what happened yesterday or today, but what will likely transpire in the future. Understanding this concept, and being aware that your own emotions may be sending you the wrong signals, can be incredibly beneficial.
As an Investment Team, we experience similar emotions as everyone else when confronted with an unexpected situation like we saw last March. Our ability to manage portfolios and make the proper decisions during these environments does not lie in our ability to block out all emotion; instead it comes from applying a consistent approach and discipline regardless of how markets are behaving. At the heart of this approach are three core tenets. The first is knowing each of our holdings (and potential holdings that we may be looking to purchase) incredibly well. If we know these businesses inside and out, it makes it easier for us to gauge the potential financial impact (positive or negative) that may arise from a specific event. The second is having a broad understanding of market sentiment so we can gauge where investors lie on the spectrum of being frightened (and possibly overly cautious) to being greedy (and possibly too aggressive). Sentiment is just one tool and it can shift quickly, but it can be helpful in identifying periods where our team may want to take advantage of investor sentiment that may be too far to one extreme – similar to what we saw last March. The third and final component is having a good grasp on valuations – understanding both what our assets are selling for at any given moment, and what we believe is a fair price. If we know a specific company’s stock is selling for a price that is well below what we believe it is worth, it makes the decision making process far easier, regardless of how uncertain the environment may be. When you can combine all three – a deep knowledge of the businesses you own, an understanding of market sentiment and having a good grasp on what your holdings are worth, it goes a long way towards removing emotions from your decision-making process.
When financial markets are calm it is easy to talk about how everyone should respond during periods of stress. And when markets are falling 10% or more during single trading days, as we saw March, it can be very challenging to follow your process. If you stay disciplined, prioritize the process instead of the outcome, and always continue to refine your approach, it makes it a lot easier. This is the reason our Investment Team was more active last year (particularly March and April) than arguably any other year in our firms’ long history. It was a wild and challenging year on so many fronts and one we don’t hope to relive any time soon. But we are happy to say that we strongly believe we were able to take actions that have positioned your portfolios even better for whatever 2021 may behold. As always, we thank you for placing your trust in our team and we wish you a Happy New Year.