Wanna Be a Market Pundit?

If you want to be a market pundit, you need to explain why markets are doing what they are doing.  To the average person, this would seem to be complicated.  But it's not once you get the hang of it!

The last 2 weeks offer an excellent example.  Two weeks ago, the employment report for October was released; and it was much stronger across the board than expected.  Stocks were expected to rise but instead dropped sharply and continued to drop the following week.  Explanation?  CNBC pundits made it perfectly clear (after the fact):  the surprisingly robust employment data pushed the odds of the Federal Reserve increasing rates sharply higher, thereby increasing economic uncertainty.  And uncertainty is the one thing that markets are fearful of! 

The horrible week ended with the 11/13 Paris terrorist attack, and markets expected the sell-off to continue unabated.  What happened?  Last week stocks had one of the best weeks of the year?  Could it be explained?  Ask CNBC if they had any problems finding people to whom it was perfectly clear (after the fact). Their explanation:  the Fed was going to increase rates and finally uncertainty would be reduced.

The sad part of this is that the pundits believe that they are actually imparting valuable information.  Unfortunately, their audience may come to the same costly conclusion. 

As Nassim Taleb stressed in The Black Swan, pundits in the financial world are adept at creating a plausible narrative for events after they happen--making them seem obvious after the fact but notoriously poor at forseeing big changes in markets.

100% in Stocks?

In an interesting MarketWatch opinion piece worth reading, "Why 100% of your investment portfolio should be in stocks," Jeff Reeves argues for investors all-in in the stock market.  The body of the piece, though, seems to argue, understandably, for that positioning for those in their 40s and below which still can be a stretch for many.

He cites the fact that, over the longer term, stocks have always moved higher.  Going back to 1926 and looking at 20-year rolling periods shows that the lowest 20-year return was a positive return of almost 11%.  It is important to note that rolling 20-year returns are obviously not independent.  By using rolling returns, analysts can cull many more data points as compared with periods that are wholly independent.

He also emphasizes the buy and hold aspect.  Jumping in and out can negate the potential positive outcome of an aggressive allocation strategy.  Furthermore, it is not easy to determine if you have the fortitude to stay the course in a really serious downturn until you've experienced one.  Whether you have the fortitude depends on personality and expectations on the use of the funds.  As I often tell people, I have seen individuals who literally have a good day when the market is up that day and are miserable when the market is down on the day.  For these people, no matter what their age, all-in is not a good idea. Actually, if you look at your account more than every couple of weeks, you should probably have some bonds for cushioning purposes.

To get a good feel for your risk tolerance, go back to the market in early 2009.  As most market observers recall, stocks were down approximately 35% in 2008.  What they may have forgotten is that the S&P 500 dropped another 25% over the first part of 2009 through the first week in March!  If you can put yourself back in this time frame, you can get a good assessment of your risk tolerance.  If you were calmly able to stay the course during this period, then your risk tolerance is high--you can readily withstand short-term down turns and focus on the longer run.

A final point to keep in mind as you read the article is that because-something-has-always-happened isn't a logical argument for it having a high probability to continue happening.  Ask the turkey, who is dutifully fed each day by the farmer, about this the day after Thanksgiving, as Nassim Taleb is fond of pointing out.

To me, the reason for aggressively allocating to stocks over the long run is the nature of our economic system.  It rewards innovation, creativity, and hard work.  The best and brightest among us are working 24/7 to bring us what we want in entertainment, the medical field, transportation, apparel, etc., etc.  This is what creates companies worth investing in over the longer term!