Here's a statement of the obvious: The opinions expressed here are those of the participants, not those of the Mutual Fund Observer. We cannot vouch for the accuracy or appropriateness of any of it, though we do encourage civility and good humor.
Umm ... Maybe that should read: "The title of this thread is misleading like most."
@John, I don't remember anyone ringing a bell and announcing in advance when past recessions were about to start. (But a lot of charlatans claimed credit after the fact). Usually it's the reverse case, with at least two quarters of negative growth rate in the rear-view mirror before economists make that call.
We've had pretty much a rocket ride upward since March 9, 2009 - 8 years. That's a long time. The Dow more than tripled during those years (albeit from very depressed levels). The one thing that is likely to trigger a slowdown is rising interest rates. And we'll have a clearer idea (I hope) of where the Fed intends to go with rates by week's end.
The upward pull of the equity marketplace is nearly irresistible. I say nearly irresistible because since 1953 the market has only experienced 10 recessions that occupied about 20% of a total period of over 550 months. In retrospect, it's a statistically healthy period of time that Burton Malkiel summarized in his "The Random Walk Guide to Investing" book.
In that historical timeframe, those 10 Bear markets declined an average of 32% and the decline lasted 10 months. The average 100% full recovery period absorbed another 21 months.
I interpreted these data to mean that I ought to keep a cash or near cash portfolio allocation that covers just under 3 years of possible needs. That safety factor surely decreased my portfolio return expectation, but that's the price for downside protection. It has served me well.
With that cushion, I don't worry much over daily or even monthly market action. Again from Malkiel, going back to 1926, the S&P 500 has delivered positive outcomes over 70%, over 90%, and over 97% of the time for periods of 1, 5, and 10 years, respectively. I like those odds.
Truth be told, I really don't worry about much of anything. What happens, happens well beyond my control.
I too agree that headlines often are misleading by design.
@MJG - You said, "In that historical timeframe, those 10 Bear markets declined an average of 32%"
You left me wondering which stock market(s) you are referring to. Is that the Total Stock Market Index (approximated by VTSMX), the Total World Stock Stock Index (approximated by VTWSX) or the S&P 500 Index (approximated by VFINX)? Perhaps it's an average of all three? Or, perhaps it refers to some other entirely different stock market index? Sorry if that's nit-picking, but not all bear markets follow the same pattern. Practically speaking, an individual's equity holdings might perform much better than that average 32% loss, or far worse - depending on the types of stocks held during the multiple year time-frame mentioned.
Another important consideration is that most investors' losses during past bear markets were to an extent mitigated as their bond holdings appreciated in value owing to falling interest rates which accompany most recessions. Coupon yields also contributed to the investor's total return. With the very low (actually extraordinarily low) yields on U.S. Treasuries today, that mitigating influence would be much less. Net-net, the "average" investor today would probably take a harder hit than he/she experienced during recent "average" past recessions. Of less significance, but worth noting, is that those "average" reported market losses exclude the additional hit from ongoing fund/investment fees, usually paid out of an investor's assets.
Your advice regarding keeping several years cash on hand is valid. I know other intelligent investors who do the same (though my approach varies somewhat). Thanks for sharing. Hope I haven't misrepresented your views or otherwise muddied the issue.
"Your advice regarding keeping several years cash on hand is valid."
I've always done this, but have to concede in hindsight that, never having needed to draw against that reserve, perhaps better use could have been made of the resource. Another imponderable- you just never know.
Thank you for reading my contribution and for your comments.
I pulled the numbers I quoted from the Malkiel book that I referenced and added the 2007-2008 equity drawdown. On page 29 of the referenced work, Malkiel states that the returns are the S&P 500 records. I did not check that statement.
I certainly concur with your observation that a diversified portfolio that includes a major set of bond holdings would greatly soften the blow of a negative equity marketplace. I followed that practice for many years.
I would note that Buffett would disagree with the diversification that I practice. Recall that he recommended a 90/10 split in his favored portfolio with 90% committed to equity positions. That's not me, especially now.
The Perennial Obsession With Constantly Predicting Recessions James Picerno @ The Capital Spectator from 6/5/2016 According to a variety of “experts,” the US has been on the cusp of a new contraction ever since the last recession ended more than seven years ago. Yet the US economy has continued to expand,Predicting otherwise, continually, is a staple among the usual suspects. The projections, however, are conspicuous only for being wrong, so far. In time, a new recession will strike. But forever seeing a new downturn around the next corner is a short cut to failure, whether you’re managing an investment portfolio or running a business. Unless, of course, you’re in the media business or selling books and newsletters that traffic in disaster scenarios. As for rolling the dice by reading the headlines du jour, well, let’s just say that history hasn’t been kind to this approach, as the following examples from recent history remind: Included :recession predictions during the past several years from Bill Gross to Larry Summers including this one that still has 15+ months for a possible outcome.
@MJG - John Bogle likes the Total Stock Market Index better as being broader. I'm not into indexing, so your S&P figures are fine with me. I guess my point is still valid that some investors will do better than that 32% loss (plus fees) and some worse during the next "average" bear market.
Here's where I have a problem: You said "I certainly concur with your observation that a diversified portfolio that includes a major set of bond holdings would greatly soften the blow of a negative equity marketplace. I followed that practice for many years."
No. That's not what I said. My observation was that your past practice (holding bonds as defense) is of less value today. Here's why. At the start of the last "Great Recession" in late 2007 the 10-Year U.S. Treasury yielded around 5%. http://money.cnn.com/2007/06/07/markets/bondcenter/bonds/index.htm?postversion=2007060717 Not only did that coupon provide an income stream during the worst of the stock market debacle, but the face value of those bonds rose during that period as rates declined, further softening the blow to investors like yourself.
Today that same bond yields less than 2.5%. That's a big difference in yield. And it doesn't bode well for investors during the next recession. I'm not the first to note it. Ed Studzinski pointed it out over a year ago in one of his commentaries and voiced similar concerns about the inability of bonds in this day and age to mitigate an investor's stock declines. But I digress ...
In your post you emphasized the rather low interest rate currently offered by bonds. I agree that will slightly dampen the benefits of a major bond allocation in a portfolio. But that is a secondary, perhaps even a tertiary, consideration during a market meltdown.
The primary benefit of a mixed portfolio is simply not having such a heavy commitment to stocks. To illustrate, consider a 100% stock portfolio and a 50/50 portfolio as an alternate. If the market tanks by 40%, the stock portfolio absorbs the entire downturn of 40%. The mixed portfolio only loses 20% even if the bond yield is zero. Bond diversification does wonders in a market meltdown by the direct impact of dilution.
I hope you sleep well tonight and other nights. I do.
MJG said, "I hope you sleep well tonight and other nights. I do."
One of the best ways to fall asleep at night is thinking about my investments. They are very boring.
But that's a terrible waste of restful time. Much prefer having Alexa read great books at night. (Just started The Grapes of Wrath.) Currently subscribe to Amazon's Audible Gold. For $15 monthly you get 1 or 2 new audio books every month and a subscription to featured stories from the WSJ or NYT. (Summaries are very well done and run about 45 minutes daily).
Humm ... In reading the board some days, I don't know how some people sleep at night!
I suspect that sleeping well at night is tightly coupled to our confidence level in our investments. That confidence level must be correlated with our investment knowledge; the more, the better.
In my earlier post, I focused on the tradeoffs between major equity to bond portfolio asset allocations. I suggest we remain focused on that tradeoff because it is critical to a comfortable retirement with its direct impact on survivable portfolio withdrawal rates. The discussion of sleep is a distraction.
Bond elements reduce portfolo average annual returns, but they also reduce portfolio volatility (standard deviation). These are competing impacts that make an allocation decision more difficult. Also the dynamic correlation coefficient between stocks and bonds changes over time which further confuses the picture.
Much good work has been done that examines these tradeoffs. Here is a Link to one such study:
@MJG - I didn't mean to infer that you don't derive comfort from those bond holdings. I'm sure you do. And I'm not forecasting calamity for folks who hold bonds as ballast. (Several of my balanced and hybrid funds hold some types of bonds.)
I intended simply to suggest that the next time around bonds aren't likely to prove as helpful as in past recessions due to their currently very low coupon rates. Hence, the "average" investor's loss in the next "average" bear market may be worse than in past ones. Obviously, there's no way to know for certain. There are many variables.
I'm sure we both sleep well. But I'll save your link in case I ever have a problem.
To illustrate Hank's point, suppose you bought a 10 year Treasury on Jan 5, 1973, and held it though Aug 23, 1974. So you'd have purchased a bond maturing on Jan 5, 1983. Assume that coupon matched market yield (newly minted bond).
Using 8.15% YTM, 6.42% coupon, and a bond calculator here, we get an ending price of $88.81. That is, the bond dropped in price by about 11%.
The yield on that bond was 6.42%/year. So over the period of 1.63 years the interest was about 10.5%. That makes the net return on the bond about -0.5% (more or less a wash), while the S&P 500 dropped from 119.87 to 71.55 (-40.3%). http://www.davemanuel.com/where-did-the-djia-nasdaq-sp500-trade-on.php
If we were to go through another period of stagflation now, with 10 year T's yielding around 2.5%, and a similar 1.73% rise in rates, the calculator shows the price declining by 13.3% (lower coupon = longer duration). Then there's the lower interest this time around. 2.5% for 1.63 years returns just 4.1%.
So this time, the same rise in interest rates (seven 1/4 pt hikes at a roughly quarterly pace) would produce a bond loss of about 9%, vs. the previous experience of a wash (including interest). Bonds as "ballast" have the potential to hasten a ship going down.
One can certainly quibble with my calculations - I've made approximations that somewhat exaggerate the losses. I've not reinvested coupons (i.e. I just computed simple interest), and I've not accounted for the shortening maturity of the bond. Making these adjustments won't significantly affect the total bond return. You'll still lose a lot.
The US employment market is much tighter than it has been the past several years. Throw a couple of trillion dollars at it in infrastructure spending and tax cuts (read: more borrowing), and you may see interest rates go up both because of increasing inflation (spurring Fed action) and the increased borrowing.
Comments
@John, I don't remember anyone ringing a bell and announcing in advance when past recessions were about to start. (But a lot of charlatans claimed credit after the fact). Usually it's the reverse case, with at least two quarters of negative growth rate in the rear-view mirror before economists make that call.
We've had pretty much a rocket ride upward since March 9, 2009 - 8 years. That's a long time. The Dow more than tripled during those years (albeit from very depressed levels). The one thing that is likely to trigger a slowdown is rising interest rates. And we'll have a clearer idea (I hope) of where the Fed intends to go with rates by week's end.
The upward pull of the equity marketplace is nearly irresistible. I say nearly irresistible because since 1953 the market has only experienced 10 recessions that occupied about 20% of a total period of over 550 months. In retrospect, it's a statistically healthy period of time that Burton Malkiel summarized in his "The Random Walk Guide to Investing" book.
In that historical timeframe, those 10 Bear markets declined an average of 32% and the decline lasted 10 months. The average 100% full recovery period absorbed another 21 months.
I interpreted these data to mean that I ought to keep a cash or near cash portfolio allocation that covers just under 3 years of possible needs. That safety factor surely decreased my portfolio return expectation, but that's the price for downside protection. It has served me well.
With that cushion, I don't worry much over daily or even monthly market action. Again from Malkiel, going back to 1926, the S&P 500 has delivered positive outcomes over 70%, over 90%, and over 97% of the time for periods of 1, 5, and 10 years, respectively. I like those odds.
Truth be told, I really don't worry about much of anything. What happens, happens well beyond my control.
I too agree that headlines often are misleading by design.
Best Wishes.
You left me wondering which stock market(s) you are referring to. Is that the Total Stock Market Index (approximated by VTSMX), the Total World Stock Stock Index (approximated by VTWSX) or the S&P 500 Index (approximated by VFINX)? Perhaps it's an average of all three? Or, perhaps it refers to some other entirely different stock market index? Sorry if that's nit-picking, but not all bear markets follow the same pattern. Practically speaking, an individual's equity holdings might perform much better than that average 32% loss, or far worse - depending on the types of stocks held during the multiple year time-frame mentioned.
Another important consideration is that most investors' losses during past bear markets were to an extent mitigated as their bond holdings appreciated in value owing to falling interest rates which accompany most recessions. Coupon yields also contributed to the investor's total return. With the very low (actually extraordinarily low) yields on U.S. Treasuries today, that mitigating influence would be much less. Net-net, the "average" investor today would probably take a harder hit than he/she experienced during recent "average" past recessions. Of less significance, but worth noting, is that those "average" reported market losses exclude the additional hit from ongoing fund/investment fees, usually paid out of an investor's assets.
Your advice regarding keeping several years cash on hand is valid. I know other intelligent investors who do the same (though my approach varies somewhat). Thanks for sharing. Hope I haven't misrepresented your views or otherwise muddied the issue.
I've always done this, but have to concede in hindsight that, never having needed to draw against that reserve, perhaps better use could have been made of the resource. Another imponderable- you just never know.
Thank you for reading my contribution and for your comments.
I pulled the numbers I quoted from the Malkiel book that I referenced and added the 2007-2008 equity drawdown. On page 29 of the referenced work, Malkiel states that the returns are the S&P 500 records. I did not check that statement.
I certainly concur with your observation that a diversified portfolio that includes a major set of bond holdings would greatly soften the blow of a negative equity marketplace. I followed that practice for many years.
I would note that Buffett would disagree with the diversification that I practice. Recall that he recommended a 90/10 split in his favored portfolio with 90% committed to equity positions. That's not me, especially now.
Best Wishes and Good Luck
James Picerno @ The Capital Spectator from 6/5/2016
According to a variety of “experts,” the US has been on the cusp of a new contraction ever since the last recession ended more than seven years ago. Yet the US economy has continued to expand,Predicting otherwise, continually, is a staple among the usual suspects. The projections, however, are conspicuous only for being wrong, so far. In time, a new recession will strike. But forever seeing a new downturn around the next corner is a short cut to failure, whether you’re managing an investment portfolio or running a business. Unless, of course, you’re in the media business or selling books and newsletters that traffic in disaster scenarios.
As for rolling the dice by reading the headlines du jour, well, let’s just say that history hasn’t been kind to this approach, as the following examples from recent history remind:
Included :recession predictions during the past several years from Bill Gross to Larry Summers including this one that still has 15+ months for a possible outcome.
If [Donald Trump] were elected, I would expect a protracted recession to begin within 18 months.
Larry Summers, former Treasury Secretary, via The Washington Post, Jun. 5, 2016
https://www.capitalspectator.com/the-perennial-obsession-with-constantly-predicting-recessions/
Here's where I have a problem: You said "I certainly concur with your observation that a diversified portfolio that includes a major set of bond holdings would greatly soften the blow of a negative equity marketplace. I followed that practice for many years."
No. That's not what I said. My observation was that your past practice (holding bonds as defense) is of less value today. Here's why. At the start of the last "Great Recession" in late 2007 the 10-Year U.S. Treasury yielded around 5%. http://money.cnn.com/2007/06/07/markets/bondcenter/bonds/index.htm?postversion=2007060717
Not only did that coupon provide an income stream during the worst of the stock market debacle, but the face value of those bonds rose during that period as rates declined, further softening the blow to investors like yourself.
Today that same bond yields less than 2.5%. That's a big difference in yield. And it doesn't bode well for investors during the next recession. I'm not the first to note it. Ed Studzinski pointed it out over a year ago in one of his commentaries and voiced similar concerns about the inability of bonds in this day and age to mitigate an investor's stock declines. But I digress ...
Good night and good luck.
In your post you emphasized the rather low interest rate currently offered by bonds. I agree that will slightly dampen the benefits of a major bond allocation in a portfolio. But that is a secondary, perhaps even a tertiary, consideration during a market meltdown.
The primary benefit of a mixed portfolio is simply not having such a heavy commitment to stocks. To illustrate, consider a 100% stock portfolio and a 50/50 portfolio as an alternate. If the market tanks by 40%, the stock portfolio absorbs the entire downturn of 40%. The mixed portfolio only loses 20% even if the bond yield is zero. Bond diversification does wonders in a market meltdown by the direct impact of dilution.
I hope you sleep well tonight and other nights. I do.
Best Wishes.
One of the best ways to fall asleep at night is thinking about my investments. They are very boring.
But that's a terrible waste of restful time. Much prefer having Alexa read great books at night. (Just started The Grapes of Wrath.) Currently subscribe to Amazon's Audible Gold. For $15 monthly you get 1 or 2 new audio books every month and a subscription to featured stories from the WSJ or NYT. (Summaries are very well done and run about 45 minutes daily).
Humm ... In reading the board some days, I don't know how some people sleep at night!
I suspect that sleeping well at night is tightly coupled to our confidence level in our investments. That confidence level must be correlated with our investment knowledge; the more, the better.
In my earlier post, I focused on the tradeoffs between major equity to bond portfolio asset allocations. I suggest we remain focused on that tradeoff because it is critical to a comfortable retirement with its direct impact on survivable portfolio withdrawal rates. The discussion of sleep is a distraction.
Bond elements reduce portfolo average annual returns, but they also reduce portfolio volatility (standard deviation). These are competing impacts that make an allocation decision more difficult. Also the dynamic correlation coefficient between stocks and bonds changes over time which further confuses the picture.
Much good work has been done that examines these tradeoffs. Here is a Link to one such study:
http://qvmgroup.com/invest/2013/07/30/historical-returns-for-us-stock_bond-allocations-and-choosing-your-allocation/
It's a rather long piece, but the subject is complex with no one size fits all solution. Enjoy the reference!
Best Wishes.
I intended simply to suggest that the next time around bonds aren't likely to prove as helpful as in past recessions due to their currently very low coupon rates. Hence, the "average" investor's loss in the next "average" bear market may be worse than in past ones. Obviously, there's no way to know for certain. There are many variables.
I'm sure we both sleep well. But I'll save your link in case I ever have a problem.
Best regards
The yield on that semi-annual bond was 6.42%. On Aug 23, 1974, the yield on 10 year Treasuries was 8.15% (probably slightly lower for this bond as it was now an 8.4 year bond).
http://www.macrotrends.net/2016/10-year-treasury-bond-rate-yield-chart
Using 8.15% YTM, 6.42% coupon, and a bond calculator here, we get an ending price of $88.81. That is, the bond dropped in price by about 11%.
The yield on that bond was 6.42%/year. So over the period of 1.63 years the interest was about 10.5%. That makes the net return on the bond about -0.5% (more or less a wash), while the S&P 500 dropped from 119.87 to 71.55 (-40.3%).
http://www.davemanuel.com/where-did-the-djia-nasdaq-sp500-trade-on.php
If we were to go through another period of stagflation now, with 10 year T's yielding around 2.5%, and a similar 1.73% rise in rates, the calculator shows the price declining by 13.3% (lower coupon = longer duration). Then there's the lower interest this time around. 2.5% for 1.63 years returns just 4.1%.
So this time, the same rise in interest rates (seven 1/4 pt hikes at a roughly quarterly pace) would produce a bond loss of about 9%, vs. the previous experience of a wash (including interest). Bonds as "ballast" have the potential to hasten a ship going down.
One can certainly quibble with my calculations - I've made approximations that somewhat exaggerate the losses. I've not reinvested coupons (i.e. I just computed simple interest), and I've not accounted for the shortening maturity of the bond. Making these adjustments won't significantly affect the total bond return. You'll still lose a lot.
The US employment market is much tighter than it has been the past several years. Throw a couple of trillion dollars at it in infrastructure spending and tax cuts (read: more borrowing), and you may see interest rates go up both because of increasing inflation (spurring Fed action) and the increased borrowing.
That's not a prediction of what the government or economy will do. It's simply a case study of how bonds can harm a portfolio in a 70s-like stagflation, where the key difference is, as Hank pointed out, lower starting bond yields.
http://www.businessinsider.com/wall-street-worried-trump-1970s-stagflation-2016-11