Downturns are not enjoyable and can create larger bumps in the road, but if we look further on, time, eventually, seems to be our friend.
“Ob-La-Di, Ob-La-Da, Life goes on” – The Beatles
Jim Shellenberger, CFA | Financial Advisor
If the markets could speak, I envision them sounding something like “Ob-La-Di, Ob-La-Da.” A melody of certainty yet words open to interpretation. In this beloved song, we don’t get caught up with worrying about what “Ob-La-Di, Ob-La-Da” means but instead sing along as if no one is listening. The investment markets often act irrationally, and if we only look at short time periods, they rarely make sense. We shouldn’t get frustrated with trying to make sense of the short-term moves. The markets will leave you crazy if you are too focused on what you should or should not have done. The goal is to make wise decisions, but you will never have perfect timing and knowledge of the markets. Here are some points to remember, so we don’t get frustrated when the markets sound like “Ob-La-Di, Ob-La-Da.”
Nothing is constant. In an ideal world, a portfolio would move up at a steady rate over time. We would love for the experience not to be rife with ups and downs. Unfortunately, that is not reality. The chart below shows the movement of a 60/40 portfolio: 60% S&P 500® and 40% Barclays Aggregate. The orange line is the 60/40 portfolio, and the blue line is the constant growth portfolio. You can see how the orange line has many ups and downs. It’s a bumpy ride almost the entire 40-year time period. Every downturn left investors with fear and uncertainty. When we are in the middle of the bumps, it gets scary, and it is hard to remember that we are getting to the same destination as the blue line. The optimist would say, “We just get a thrill ride the way there.” Uncertainty and fear will most likely always exist in the markets, but overall, historically, the markets have had a bias upwards. This portfolio went from $100 to about $5,000 in about 40 years: a bumpy ride but a relatively good outcome in the end.
Recessions are unpredictable. Every downturn in the past has been unique to what caused it, and, subsequently, the route taken by the markets to adjust and recover is also unique. Unfortunately, recessions get even bumpier. Below is a chart of a 60/40 portfolio during the tech bust of the early 2000s. From peak to the bottom, this portfolio would have lost about 23%. You can see that it was not a quick and direct path to the bottom. It took about two years. It is quite troubling when your portfolio has been up and down (mostly down) for a year and a half, and then, to top that off, the most significant drawdown of the recession, one of 15%, hits at the end. Unfortunately, it is currently possible that we may test the “bottom” we experienced in March.
It is not out of the realm of possibility. However, we could also have an experience similar to what we saw in 1987 when the S&P 500® went down and right back up. It created a nice “v-shaped” downturn and recovery. Even though an experience like the tech bust is disturbing and hard to see through, things turned out well in the end. This 60/40 portfolio has more than doubled since the beginning of the tech bust. Once again, a bumpy road but a rather good eventual outcome.
Time seems to heal wounds. If we focus on the long-term, things get less scary. If we only focus on the short-term, downturns are frightening. Counter to our initial feeling of fear, it is possible that they produce long-term buying opportunities. Let us look at a 60/40 portfolio during three notable downturns in the last 40 years.
The point to note is that the 5-year cumulative return and the 10-year cumulative return start the month the downturn began. That means that for the 1987 downturn, the 5-year cumulative return of 62% includes the 17% drawdown from the initial peak to bottom. No investor wants to see their 60/40 portfolio down 17-33%; however, the silver lining is if we look five to ten years out from the start of these downturns, we still had a positive return. The least impressive returns are for the tech bust. One thing to consider is that tech bust took 25 months to get to the bottom and 25 months to get to a new high. This means that 50 months of the 5-year (60 months) cumulative return was downturn and recovery. Another thing to consider for the 10-year cumulative return is that the tail end of that 10-year return overlaps with the 2008 financial crisis, yet it was still able to return 22%. Downturns are not enjoyable and can create larger bumps in the road, but if we look further on, time, eventually, seems to be our friend. They have the potential to end up being buying opportunities, though it is generally wise to proceed with care.
A bumpy road is never fun, but when we get to where we are going, we tend to forget about the road and remember the destination. Unfortunately, we will always experience volatility in investments, but instead of always viewing them as a nuisance, we should try to see them as long-term opportunities. In the long run, these downturns can become good buying opportunities. We are currently in the “middle” of a downturn. We can hope it works similar to the 1987 downturn and makes a nice “v-shaped” recovery, but we also need to prepare that it could act more like the tech bust. If we end up testing lows from earlier in the year, know it is part of the journey and remember, its a marathon, not a sprint.
First and foremost, prepare as if things could get worse and know what you will do. Have a backup plan. It is better to be prepared and have nothing happen than to live, hoping that nothing will happen and be caught off-guard. Even though things may sound like “Ob-La-Di, Ob-La-Da” in the short term, remember “life goes on,” and things generally work out for the best, in the long run.
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|S&P 500||Represents U.S. large company stocks. It is a market-value-weighted index of 500 stocks that are traded on the NYSE, AMEX, and NASDAQ|
|Barclays US Aggregate Bond||Measures the performance of the U.S. investment grade bonds market. The securities must have at least one year remaining to maturity, must be denominated in U.S. dollars and must be fixed rate, nonconvertible and taxable.|
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