Market Rationality (Or Lack Thereof)

I’ve had a number of conversations recently with clients and other investors who have asked me: “Why have the equity markets stayed on the high end of their 52-week (and also all-time) ranges over the summer months?”  I always start my answer with a disclaimer: “Well I don’t know, but…” When we seek evidence for market rationality — an explanation of the market’s behavior in the short term — it can easily become a foolish pursuit.

 “The market can stay irrational longer than you can stay solvent.” – John Maynard Keynes

This, I believe, should be an absolute maxim carved in stone to remind the investor with an eye towards retirement. To avoid borrowing money (also known as leveraging) to invest. That approach is a good way to create an opportunity for an investor to “lose it all.”

The current market: how did we get here?

It’s basically impossible to know exactly all of the reasons the market is doing what it’s doing… at any given point, at any given time. But we can easily identify that there’s uncertainty in the financial world today. The coronavirus continues to impact economies all over the world and the eventual resolution of that situation is completely unknown. Unemployment in America is high, and we can’t predict when people will get back to work — or even if they’ll ever get back to previous employment levels in some industries. Plus, there is an election in less than two months in which our country will have to choose between two radically different approaches to fiscal policy and taxation (but either choice seems to be in favor of more and more spending deficits). Hence, you would probably expect these issues to cause a drop in market levels.

On the other hand, we do have a Federal Reserve, a Congress, and an Administration that have demonstrated a willingness to aggressively offer fiscal stimulus and/or relief to ward off a potential recession. We also see people searching for yield and choosing dividend-paying equities as their perceived best option. Corporate earnings have held up in some sectors, so some businesses continue to find opportunity in this environment. These issues argue (perhaps) for higher markets.

All of that being said, we can wrangle over these issues, ad nauseum, and still be unable to find a rational explanation that explains market performance for this week, last month, or the rest of the year.

Back to the basics: long-term investing in the midst of uncertain markets

I was discussing this issue with my colleague Kyle Cobia (who, by the way is worth getting acquainted with if you haven’t already). We agreed that much of these market discussions are causing us to simply over-think the investment process. Granted, discussions of why the market goes up or down is perhaps one of the main topics of financial television shows and advertisements.

However, while it may be interesting, it is mostly noise when it comes to long-term investing. Kyle and I agreed that when investors find themselves in the swamp of “too many questions,” it is time to go back to the basics —to “tend to your knitting.”

Kyle pressed me to explain my personal basics in the simplest terms, which involved getting rid of references to further complexities. I thought it was a good exercise, as it was helpful in defining the basics of the investment plan we are always talking about. This is a crucial step in developing a plan, despite being unable to pinpoint market rationality (see below for the list I came up with).

A simple guide to investing in 2020:

1. Live on a budget within your means; develop a loathing for consumer debt.
2. Save a minimum of 10% of every dollar you ever earn. (It’s hard to be an investor without money to invest!)
3. Sock away enough cash for your known future purchases as well as potential emergencies.
4. Understand market volatility and investment risks.
5. Define your investments goals. Include “must haves” and “nice to haves”.
6. Investment in a diversified portfolio that meets your risk tolerance and investment goals.
7. Add to your investments when you have the money and sell from your investments when you need the money.
8. Rebalance your portfolio once a year — or when you aren’t sleeping because of your investments.

If you enjoy discussing the market and the surrounding issues — have at it! But know that times of uncertainty should confirm that your long-term investment approach is the right one rather than cause you to alter the course you have created with thought and care.

October 2020