This Time It's Different (But It's Not)

Close-up of stock market ticker

What just happened?!

The year 2016 began with what ended up being the worst six-week start in equity market history. The S&P 500 Index declined more than 11 percent from its 2015 close through February 11. In June, the markets dropped nearly 6 percent in a day-and-a-half of trading following the Brexit vote. And there was a moment, somewhere around 2:00 A.M. Eastern time after the presidential election, when I saw the futures on the Dow Jones Industrial Average down 800 points! Yet despite all that unnerving market volatility, the S&P 500 closed out the year at record highs. In a sense, the equity markets put on a tutorial in 2016, highlighting the wisdom of tuning out shocking current events and the attendant volatility. During such episodes, it seems to me that the best investment advice I can offer is always, “Turn off your television.” There can be little doubt that the primary driver of major market uncertainty in the second half of the year was the U.S. presidential election. Indeed, the pall of ambiguity was so heavy in the run-up to the voting that the S&P 500 managed to close lower on nine consecutive trading days, a feat not accomplished since 1980. Thus, the most important aspect of the election from the market’s perspective may simply be that it’s over. We know the outcome, and that’s no small thing, because in my experience, what the equity market hates most is uncertainty. It can deal with anything, as long as it knows what it’s dealing with.

Where are we now?

So, we now find ourselves in what can reasonably be called the new normal, but in truth it looks quite a bit like the old normal and will very probably act like it as well. With wage income growing at an accelerating rate, business investment poised to potentially rebound, and government spending growth potentially increasing, the economy is poised for continued sustainable growth. If wage growth increases, consumer spending power could increase more quickly. If consumer borrowing were to pick up, spending could grow even faster. Business investment could respond to improving demand and rise more than expected. Local and state governments could increase investment and hiring more than expected. The risks are primarily political. Here in the U.S., the Trump administration will have to come to terms with Congress over actions and priorities; while there is substantial overlap, there are also substantial differences. Abroad, changing U.S. policies will continue to rattle the world even as major players face their own internal challenges. The other major domestic downside risk involves the effects of rising interest rates now that the Federal Reserve (Fed) has restarted the increase cycle. Expectations are for at least three increases in 2017. Should rates rise too far too fast, the economy could slow. The Fed is aware of this, however, and is determined to remain part of the solution rather than becoming part of the problem, so the most probable case remains very slow rate increases that support continued economic expansion. There are many additional factors that may contribute to more volatility which, again, is a return to normal. Absent the Fed’s security blanket, the market should be more volatile, and I believe it will be. Although U.S. financial markets reached new records as the year ended, improving fundamentals and sentiment still support further potential appreciation from current levels. Continued improvement remains probable, with earnings growth likely to accelerate in 2017 and valuations anticipated to quite possibly increase, in general, with an improving economy. The outlook for foreign markets is more uncertain, however, as the effect of quantitative easing on those markets has been to increase valuations above historic norms, and both political and economic risks remain substantial.

Where do we go from here?

Generally speaking, my experience has been that successful investing is goal-focused and planning-driven, while most of the failed investing I’ve observed has been market-focused and performance-driven. Another way of making that same point is to tell you that the really successful investors act continuously on a prudent investment plan—tuning out the fads and fears of the moment—instead of continually and randomly reacting to economic and market “news.” Most of my clients are working on multi-decade and even multigenerational plans for such great goals as retirement, education, and legacy. Current events in the economy and the markets are, in that sense, distractions of one sort or another. For this reason, I adamantly discourage clients from shifting investment policy based on today’s or tomorrow’s headlines. Instead, I attempt to align each portfolio with its client’s most important long-term goals. I believe that my highest-value services are planning and behavioral coaching, helping clients avoid overreacting to market events, both negative and positive. I believe that, historically, temporary market declines are different from permanent loss of capital, and that the most effective antidote to any volatility has simply been the passage of time. I fall back on the wisdom of the great investor and philanthropist, John Templeton, who said that among the four most dangerous words in investing are “it’s different this time.”

The nature of successful investing is the practice of rationality under uncertainty. We’ll never have all of the information we want, in terms of what’s about to happen, because we invest in (and for) an essentially unknowable future. Therefore, we practice wealth management principles that have reliably yielded favorable results over time: sound planning, rational optimism based on experience, patience, and a disciplined investment process. These will continue to be the fundamental building blocks of our investment advice in 2017 and beyond.