Lessons For The Next Crisis

This article from Dimensional: Lessons for the Next Crisis recaps what we have learned from past major crisis-related events. The information is very applicable to what we are experiencing right now.

It is difficult to draw useful conclusions based on such
observations; financial markets have a habit of behaving
unpredictably in the short run. There are, however,
important lessons that investors might be well-served
to remember: Capital markets have rewarded investors
over the long term, and having an investment approach
you can stick with—especially during tough times—may
better prepare you for the next crisis and its aftermath.

The Toll of New Trade Tensions and Your Portfolio

It was hard to miss the headlines about escalating trade tensions between the U.S. and China this week—and hard not to notice the up-and-down market activity that went along with it. But what, if any, long-term impact does trade policy have on the economy and, by extension, our portfolios? The BAM ALLIANCE’S Director of Investment Strategy Kevin Grogan explores this topic in the following article, and reminds us, once again, that although it remains to be seen how the events of this latest news cycle will play out, your evidence-based financial plan is built to anticipate and withstand market risk.


News of an escalating trade war between the U.S. and China dominated headlines in recent days as the government imposed new tariffs on $200 billion of Chinese imports when the latest round of talks broke down. Per Bloomberg, the U.S. has set a deadline of “three to four weeks” for negotiations to produce a deal before the U.S. imposes additional tariffs. The most recent impasse follows a series of negotiations over the past 18 months. The S&P 500 is down about 3% so far this month in response to the news.


The Trump administration’s apparent goal with its various tariff programs is to 1) secure what it sees as a better trade balance, and/or 2) procure more advantageous trade terms by using U.S. tariffs as a tactic for compelling other countries to eventually lower their own tariffs on incoming U.S. products.


It is important to point out that, trade terms aside, a negative trade balance isn’t necessarily the same thing as being on the losing side of a trade relationship. Consider the following analogy: You buy (import) produce from, but don’t sell (export) produce to, your local grocer. This opens a negative “trade balance” with the store. Nevertheless, you probably don’t see yourself as somehow coming out short in a deal where the store gets your cash and you get dinner.


What long-term impact the Trump administration’s tariff policy will have on the economy remains to be seen. For instance, we don’t know whether even higher tariffs on even more goods imported from even more countries will be levied (or not), or how long reciprocating tariffs could be in effect. In addition, tariffs that in theory should represent only a minor drag on the economy may have an outsized influence, depending on how consumers perceive and respond to them. What we do know is that tariffs raise prices, effectively amounting to a tax on consumers. There is evidence that the tariffs already in place have had an impact on consumers since they went into effect. That is why, in the end, no one “wins” trade wars, making them a detrimental prospect for all involved. We are well aware that such events, however unpredictable, can and will happen. That’s why we build long-term, evidence-based financial plans to anticipate and incorporate market risks.


Before considering any drastic action with your portfolio, it may be helpful to recall that the stock market is forward-looking, so it already has incorporated its best guesses for how the current tariff situation will (and a lengthy trade war would) play out. And this information already is reflected in prices. Furthermore, we simply do not know how the game will end. If the Trump administration’s strategy to confront U.S. trade partners works, and all tariffs come down, it would be a huge win for the world, not just domestically. If the strategy precipitates an even bigger, all-out, long-term trade war, it likely would lead to lower economic growth around the world, with the consolation prize being that the U.S. would likely be affected the least.


In a trade war, relatively speaking, the U.S. tends to weather the storm better because trade is a much smaller percentage of U.S. gross national product than it is for most countries. This likely explains much of U.S. stocks’ outperformance over the past couple years. In the event of a trade war, small-cap stocks tend to do better than large-cap stocks because, in general, they are exposed to less global trade. Again, this likely helps to explain small-cap stocks’ outperformance since the beginning of 2018. Moreover, the dollar tends to strengthen as investors flee to safety and liquidity.


Conversely, international stocks tend to do worse in a trade war, and emerging market stocks tend to do the worst of all because their economies often are more reliant on global trade and their currencies take a hit from investors’ flight to safety. This can be a double whammy for foreign economies, as much of their debt tends to be in dollars (which are appreciating relative to other currencies, making debt financing more expensive). That is exactly what has happened as the risk of an extended trade war has increased.


If the market anticipates that the odds of a full-blown, long-term trade war are rising, investors likely will see more of this type of action. When the odds of a bad outcome seem to decrease, likely the reverse will occur. Indeed, an increasing risk of continued trade conflict likely explains equities’ relative performance (that is, it helps explain why U.S. stocks, particularly U.S. small-cap stocks, are outperforming).


In virtually all cases, economic or geopolitical news is not value-relevant information, unless you have a copy of tomorrow’s newspaper. The prudent course of action remains to adhere to your comprehensive financial plan, ignoring speculation in the financial media. The only time you should alter your plan is when your assumptions about your ability, willingness or need to take risk have changed.


Information from sources deemed reliable, but its accuracy cannot be guaranteed. By clicking on any of the links above, you acknowledge that they are solely for your convenience, and do not necessarily imply any affiliations, sponsorships, endorsements or representations whatsoever by us regarding third-party Web sites. BAM Advisor Services is not responsible for the content, availability or privacy policies of these sites, and shall not be responsible for liable for any information, opinions, advice, products or services available on or through them.

© 2019, The BAM ALLIANCE®

The 5 Stock Market Crashes I’ve Lived Through —

Re-posted from Apple News

We get more pain from losses than pleasure from gains—which might explain why I often think back on the five major market crashes that have occurred during my investing lifetime.

There’s something about the massive hemorrhaging of money that has a way of focusing the mind and sticking in the memory.

Here are those five crashes, and what I learned from each:

Black Monday

I was age 24—with no money invested in stocks—when the S&P 500plunged 20.5% on Oct. 19, 1987. I still vividly recall the shock of the market’s stunning decline, as well as the palpable sense of panic among both Wall Streeters and everyday investors.

Black Monday was a classic example of why you shouldn’t panic during periods of market mayhem. Those who dumped their shares got out at the market low or close to it. But that was hardly the only lesson to be learned.

For months after, commentators harped on the possibility of a recession that never came to pass. Anyone who listened missed a great opportunity to buy stocks at bargain prices. Are the talking heads talking? Try mightily not to listen.

Tech wreck

The late 1990s tech-stock boom was a textbook bubble, the madness of crowds on full display, with investors buying simply because others were buying. For me, it was a baffling time. I barely comprehended what all these start-up technology companies did, let alone why investors were so excited about their prospects. Most other investors, I assume, were equally clueless. But that didn’t stop them from bidding tech shares ever higher.

In fact, I suspect that, for many, their lack of understanding fueled their desire to buy. It’s the same reason hedge funds continue to attract investor dollars, despite wretched returns. It’s the reason people imagine an article is more insightful if stocks are called “equities” and bonds are labeled “fixed income.” It’s why folks shoveled money into bitcoin in 2017, despite scant understanding of cryptocurrencies and blockchain technology. It’s almost as if folks say to themselves, “If it’s confusing, it’s got to be clever—and lucrative.”

Nothing could be further from the truth. To invest successfully, we need to stand apart from the crowd, never purchasing something we don’t understand and never buying just because others are doing so. That doesn’t mean we should be knee-jerk contrarians. But it’s crucial to diversify broadly, while shunning big bets on the market’s most popular merchandise.

Housing bust

Even now, I find it flabbergasting that the housing bubble could follow so quickly after the tech-stock bubble. Did folks learn nothing?

In fact, the housing mania was arguably even worse than the tech mania that preceded it. It affected far more people. Barely half of Americans own stocks, while—at the time—almost seven out of 10 owned their home.

On top of that, the housing boom and bust involved a large, undiversified, illiquid and often leveraged asset. If you own a diversified stock portfolio, you can’t lose everything, unless you buy on margin. But with homes, leverage is a way of life—and it’s all too easy to have your home equity wiped out.

The financial pain of the housing bust was exacerbated by the psychological shock: Folks expect stocks to be risky, but they’d long viewed homes as the safest of investments. The 27.4% peak-to-trough decline in the S&P CoreLogic Case-Shiller national index shattered that perception. Even now, I sense a lost innocence about real estate, though the crash—like all crashes—will eventually be forgotten, leaving us vulnerable to another mania.

Great Recession

The housing market peaked in mid-2006. Initially, it seemed the subsequent bust would be felt only by foolish mortgage lenders and borrowers.

But 18 months later, the economy started contracting and, soon enough, the reverberations from soured mortgages were pummeling the world financial system. The global economy’s interconnectedness was never more apparent. You and I may be sensible. But that doesn’t mean we won’t pay a hefty price for the speculative excesses of others.

Even in early 2009, with stocks at half 2007’s level, valuations weren’t especially compelling—and yet it was a great time to buy. Admittedly, purchasing stocks simply because they’ve fallen sharply seems like the most naïve of strategies. But I’m not sure there’s any alternative: Thanks to the rising valuations of the past three decades, we can no longer look to average historical valuations—whether it’s price-earnings ratios, the Shiller P/E or something else—to figure out whether stocks today are a compelling investment.


The Great Recession and accompanying 57% plunge by the S&P 500 may have been the biggest crash of my investing lifetime and the greatest buying opportunity. But I don’t think it was the most significant.

Instead, I’d argue that honor goes to Japan’s three-decade bear market. Imagine it’s 1989 and you’re a Japanese investor who suffers from home bias—the preference for investing only in local companies. Today, almost 30 years later, you’d be sitting with shares whose prices have been almost cut in half, and your financial dreams would likely be in tatters.

Could a three-decade bear market happen elsewhere? Of course. Could it happen in the U.S.? I doubt it. But I can’t rule it out, which is why I worry whenever investors tell me they own.

Could a three-decade bear market happen elsewhere? Of course. Could it happen in the U.S.? I doubt it. But I can’t rule it out, which is why I worry whenever investors tell me they own only U.S. stocks—and it’s why I keep half my stock portfolio in foreign shares.

Yes, there are all kinds of arguments for why U.S. investors should avoid foreign stocks. Folks note that property rights and accounting standards are weaker abroad. They say U.S. companies have such extensive international operations that there’s no need to buy foreign shares. Indeed, according to Morningstar, 38% of the revenues of the S&P 500 companies come from outside the U.S.

Perhaps, under normal circumstances, U.S. investors could fare just fine without foreign stocks. But what if circumstances aren’t normal? As we learned from the 17th century philosopher Blaise Pascal, when we ponder the risks we face, we need to think not only about probabilities, but also about consequences. It’s extraordinarily unlikely that the U.S. stock market will be the next Japan. But, if it came to pass, imagine what the consequences would be for your portfolio—and for your ability to meet your financial goals.

This article originally appeared on MarketWatch.

Swedroe: Do Surprises Really Move Markets?

French economist Louis Bachelier long ago remarked: “Clearly the price considered most likely by the market is the true current price: if the market judged otherwise, it would not quote this price, but another price higher or lower.”

Prices will not change if the expected happens. It is the unexpected that causes prices to move.

In an efficient market, any new information the market receives will be random, not in the sense of being good or bad, but in the sense of whether it surpasses or falls short of the expectations that are already built into the current price.

The market quickly incorporates new information and revalues the security. The volatility of both the stock and bond markets is evidence of the frequency with which the expected fails to occur.

The following examples from my first book, “The Only Guide to a Winning Investment Strategy You’ll Ever Need,” demonstrate that it’s surprises—not whether news is good or bad—that drive changes in prices. They show how good (bad) news can lead to bad (good) results.

Good News, Bad Results

On Feb. 4, 1997, after the market had closed, Cisco Systems [check out our stock finder] reported that its second-quarter earnings had risen from $0.31 per share in the prior year period to $0.51, an increase of 65%.

No one would suggest that a rise in earnings of that magnitude is bad news. Yet the price of Cisco’s stock fell the following day from its prior close of just over $67 a share to $63, a drop of 6%.

The price drop can be explained by the fact that the market was anticipating a greater increase in earnings than the company reported. Prior to a company’s release of information, outsiders do not know whether it will report earnings higher or lower than market expectations.

Bad News, Good Results

A similar phenomenon occurs when a company’s stock price rises after a “bad” earnings report. For example, the day IBM [] released its earnings for the second quarter of 1996, the price of its stock rose 13%.

Based on the price movement, one would have thought that IBM had announced spectacular results. Their earnings were, in fact, down about 20% from the same period of the prior year.

The stock rose because the market was expecting IBM to announce far worse results.

Surprises Unforecastable

Because surprises are by definition unforecastable, whether subsequent information will affect the price of a stock in a positive or negative manner is random. The fact that the academic research, including papers such as “Luck versus Skill in the Cross-Section of Mutual Fund Returns,” has found that fewer active managers (about 2%) are able to outperform their appropriate risk-adjusted benchmarks than would be expected by chance demonstrates that the markets are highly efficient at setting prices.

Despite the research findings, there remains a huge industry dedicated to trying to outguess the “collective wisdom” of the market and exploit surprises. The investment research team at Vanguard provided some insights into just how successful you might need to be to exploit economic surprises in its November 2018 paper, “Here Today, Gone Tomorrow: The Impact of Economic Surprises on Asset Returns.”

Anticipating Surprises

They began by noting that the belief that motivates tactical allocation strategies is that a surprise can be foreseen by prescient analysts. With that in mind, they asked the question: “How prescient do you need to be to exploit economic surprises?”

To answer that question, they built a simple model using data from the last 25 years. The economic measure used is the nonfarm payroll.

  • They start with a 60% U.S. equity (represented by the MSCI USA Index)/40% U.S. bond (represented by the Bloomberg Barclays US Aggregate Bond Index) portfolio.
  • In advance of any positive economic surprise, they increase their equity allocation to 80%.
  • In advance of any negative economic surprise, they decrease their equity allocation to 40%.

Not surprisingly, they found that if you had perfect foresight, your returns increased. However, the improvement in returns was just 0.2% per annum—and that’s before even considering trading costs, and for taxable investors, taxes. To break even with the 7.4% return of the benchmark 60/40 portfolio, the investor would have had to be right 75% of the time (again, that is before considering implementation costs).

Given today’s highly competitive markets, the odds against being able to successfully exploit mispricings after implementation costs seem daunting. Yet in a triumph of hype and hope over wisdom and experience, most investors are still engaged in that endeavor.

Vanguard’s research team concluded: “The odds of successfully trading on surprises is low.” They added: “What can seem consequential in the short run is irrelevant to the long-term investor. Short-term surprises are quickly priced into long-term expectations, and these long-term projections have almost no relationship to future returns.” (There is little relationship between economic growth and stock returns.)

I hope you will keep Vanguard’s findings in mind the next time you are tempted to tactically allocate based on your (or some guru’s or money manager’s) forecasting ability. And if you are still tempted, remember that an all-too-human trait is overconfidence in our abilities.

I offer one other suggestion: Start keeping a diary, writing down every time you are convinced the market is going to go up or down. After a few years, you will realize that your insights, unfortunately, are actually worth nothing.

Larry Swedroe is the director of research for The BAM Alliance, a community of more than 140 independent registered investment advisors throughout the country.

Is the Stock Market Undervalued? Data Says Yes

Read the full article here:

After a few weeks riding the stock market roller-coaster, financial journalists are trying to explain what is causing this extreme volatility.

There seems to be a new “fear of the day” knocking down the stock market. Chinese trade talks, Brexit, government shutdowns, Fed rate hikes, inverted yield curves or Trump’s tweets all seem to be culprits in this conspiracy to drive down the stock market.

Since none of these issues have any significant impact on the underlying U.S. economy, why do they cause so many declines in the stock market?

To answer that question, investors have to go back to Economics 101—in the long-term, the U.S. stock market always reflects the trend and direction of the underlying U.S. economy. Right now, the U.S. economy is currently on pace for its fastest growth since 2015. Historically, stock market corrections, fueled by political, foreign policy or governmental issues, usually last only a month or two, and, when it dawns on investors these issues do not impact the underlying economy, the market recovers quickly. These correction recoveries are usually V-shaped—fast and high.

Now for some good news. Investors can take comfort in the fact that the current correction in the equities has left the stock market undervalued. According to FactSet, the current 12-month forward price to earnings ratio for the S&P 500 Index is currently at 15.4 times annual earnings. This P/E ratio is now well below the 5-year long-term average of 16.4. At the sector level, the Consumer Discretionary sector has the highest forward P/E ratio of 19.8, while the Financials sector has the lowest forward P/E ratio of 11.1, per FactSet.

For the time being, investors can only consider forward P/E ratios, because the traditional backward looking, trailing P/E doesn’t include the effects of several months of tax cut legislation that didn’t go into effect until earlier this year.

With the S&P 500 index so undervalued, investors need to adhere to the advice their grandmother gave them as a child: buy low and sell high. The reason to invest now is the consensus forecast for the S&P 500 Index will increase in price 17.1% over the next 12-months, according to consensus estimates compiled by FactSet of 11,125 analyst’s ratings for S&P 500 companies.

Paul Dietrich is the CEO and Chief Investment Officer of Fairfax Global Markets LLC, a Registered Investment Advisory firm. He is also an international corporate attorney and has been an advisor on privatization and economic development issues to the World Bank, as well as several governments in Asia, Eastern Europe and the former Soviet Union.