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Why I dumped all my holdings despite believing in “stocks for the long run”

Simple log extrapolation to 2020-end based on experts’ forecasts; for illustrative purposes – could be S-shaped and plateau sooner, but still a curve to mount. 2020-end forecasts from University of Massachusetts Amherst survey results.

Backdrop:

I’ve been getting a lot of questions from investor buddies, friends and family about whether they should stick to their stock holdings with the current market turbulence or reduce them and wait for a better entry point. Historically, I advise people to not fool around and am an advocate of stocks for the long run. However, I’m “violating” my own principles in light of the present unique situation. These are special times.

What is the stocks for the long run philosophy?

The logic goes a bit like this: No one can perfectly time a market, but if they hold their money in the stock market, over time, since they are investing in continued economic and financial growth, they will be compensated for the inherent risk. The key qualifier being “over time.” And, coupled with this philosophy, is a view that one cannot “time the market.” Below is a compelling illustration showing that if you held the S&P 500 (or some ETF proxy) from 2000 to present, you’d have made 156% in total return space. However, suppose you tried to get “cute” and trade around; if you happened to miss the top 15 days in the market, you’d be down 10%. Point being, unless you have amazing insights that tell you precisely when to get in and out, you’re better off just sticking to it.

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Why might stocks for the long run be wrong?

While we have data back to the 1800’s on stocks, and stocks for the long run is viewed as conventional wisdom, this market may be different from history for two primary reasons:

(1) The market is highly concentrated with technology/healthcare accounting for almost half the market. The S&P 500 is a cap-weighted index and evolves over time. With the rise of FANMAG (Facebook, Amazon, Netflix, Microsoft and Alphabet), the market is almost 50% technology/healthcare. Lately, gains have been driven by multiple expansion rather than earnings growth, and we can see that growth stocks have dramatically outperformed value stocks for many years, which when the trend reverses, can be powerful.

(2) For almost a century, the economy has benefited from a “Great Moderation” of smoother, longer cycles, with industrial production volatility falling. With an unprecedented shock to the global economy driven by the coronavirus pandemic, the assumption of continued low volatility seems questionable.

In short, this is not your grandpappy’s market; you’re likely implicility betting on FANMAG and for the world as we knew it to continue.

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Where are we?

Let’s drill into two main drivers of the market and economy: oil and the consumer.

(1) The market’s correlation to oil has risen to almost 75%; pick any stock and plot it versus oil over time, and you’ll see the relationship getting tighter. At core, the US economy has become net long oil, not only from a direct production perspective, but from indirect effects on the industrial sector. This is why, for example, in 2015, we had an “industrial recession” when oil fell to the $40’s/bbl, with ISM moving into contraction territory (below 50).

(2) The “industrial recession” did not impact the broader economy and growth because of the consumer, which has long been a US strength that presently accounts for almost 70% of GDP.

With oil having fallen dramatically in the past month and coronavirus and related quarantines leading to a spike in jobless claims, there is an unprecedented consumer shock underway. The twin oil shock and consumer shock are likely not yet reflected in ISM and consumer confidence data. Does it seem prudent to step in front of that?

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Where are you and what are you betting on?

While the stocks for the long run philosophy is sound, let’s acknowledge that implementing that strategy still involves a bet…an increasingly popular bet, which makes it less attractive. And concretely, maintaining this strategy in the face of a shock never witnessed before in the historical analysis, implicitly means you’re looking through coronavirus and its implications, especially since we have not even climbed the death curve.

And that may be a fine strategy, provided you truly have the horizon. But I suspect many investors take the conventional wisdom of stocks for the long run and apply it even when they don’t have the staying power to hold over a 30 year window (life happens, withdrawals happen). That’s likely one driver of why investors underperform the market over time; they don’t fully and truly implement buy and hold. They “cry uncle” when retirement comes and they need income or beforehand.

So take stock of your retirement situation; ask yourself if you can truly withstand a possibly 15-30 year window where you don’t recover your losses (because those windows do exist in the historical analysis). If you can, you’ve likely positioned yourself well. But if you can’t, then you’re really not implementing stocks for the long run anyways. There’s a calculator below to help with this.

I’m not staying out of the market forever. I’m not sure if this actually “violates” stocks for the long run. When I backtest sitting out a few months, the strategy still works…so long as you don’t make a habit of it.

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What’s next and when to get back in

I don’t take this decision to violate my personal investment strategy lightly, and this may not be the solution for everyone. Maybe you have enough if the market falls to still retire comfortably, but if you’re banking on it, I’d take stock…because this is not your grandpappy’s market.

In future: I’ll provide some guideposts I’m looking at for reentry. Hint: A turn in the second derivative of coronavirus deaths in the US.