Market Commentary
What does it mean to be a long-term investor?
October 2016
"The stock market is the story of cycles and of the human behavior that is responsible for overreactions in both directions."
- Seth Klarman
"Bull markets are born on pessimism, grow on skepticism, mature on optimism and die of euphoria."
– John Templeton
Conventional wisdom tells us that, as investors, we should be focused on the long term. But what does that mean exactly: five years, ten years, longer? The answer generally is – it depends. Since "it depends" is about as satisfying of an answer as a parent saying "because I said so" we have decided to look at three underlying questions about being a long-term investor:
- If I’m focused on the long-term, how much attention should I pay to short-term events like the election or interest rates?
- How long is long-term and what is that length based on?
- What is the right time frame for me, individually?
First, why is there so much focus on short-term news cycles if most people claim to be invested for the long-term? It seems misrepresentative that if you look at Bloomberg or most other financial websites the first chart they show is the intra-day change. From a long term investor’s perspective, the last 6 years provides a more relevant view than the last 6 months, and the last days and weeks are particularly unimportant. Human nature pays the most attention to recent events, though, despite the difficulty of predicting the next near term change in a trend.
Recently, we have enhanced our model construction methodology in part to help us further focus on the long term, and to sort the more useful signals from the short-term noise. Using a somewhat broader set of sub-asset classes, we ground our portfolios in useful diversification and discipline. Certainly we want to respond to market conditions – and minimize exposure to overpriced assets while increasing exposure to areas of possible opportunity – but the core portfolio exposure still seeks to achieve good growth in value over the intermediate and longer term.
While the common investment disclaimer that 'past performance is no guarantee of future results' is correct, we also understand that history can be an insightful teacher. We understand that smaller company stocks tend to perform better in expansionary periods and protect against inflation and bonds and real estate tend to underperform in periods of rising interest rates. We have studied these and other persistent relationships in order to create a diversified foundation of investments that is designed to grow as a whole in different environments. The foundation of our portfolios remains owning good businesses and staying invested instead of managing towards a single event that might or might not come to fruition in the way we expect.
Now let’s return to the tricky question, how long is long-term? With investing, we often frame long-term expectations around a complete business cycle. Unlike a presidential election cycle or the Olympics that we know occurs every four years or even the seventeen-year cicada cycle, business cycles are considerably more random. The official scorekeeper of the U.S. economic cycle is the NBER, or National Bureau of Economic Research.1 By their reckoning, since the middle of the 19th century there have been 33 business cycles. The average expansion has lasted 38 months but has varied from as short as 10 months to as long as 10 years. Contractions are considerably more rapid and have averaged about 18 months but have been as brief as six months and endured for over six years. The last 11 business cycles have averaged roughly 6 years and when we talk with our clients and colleagues about being a long-term investor this is one of the places we start with, because at the end of the day we think and invest as business owners.
That is the business cycle, but what about the market? The market’s own cyclical nature is directly linked to the business cycle, but the timing is different because of the forward looking nature of the market. Since the mid-50’s the average bull market has lasted for 52 months and have generated gains of over 150% on average.2 Again, your mileage may vary. Market expansions have been as short as 26 months and have lasted nearly 10 years. Like the economic contractions, bear markets tend to be shorter than bull markets, lasting just 14 months, typically, and result in an average decline of 27%.
Secular interest rate cycles are typically longer than economic or stock market cycles. The current interest rate cycle dates back to the early eighties when we were experiencing double digit government bond yields.3 Three and a half decades and three Fed Chairpersons later, the 10-year US Treasury interest rate is a mere 1.72%; a healthy return by international standards today, when over 70% of developed country government issued debt pays less than 1%. The preceding period rising rates lasted over two decades from the late 50s to 1980 when rates climbed from below 3% to over 15%. And while we don’t know what catalyst will get interest rates rising again, when that process develops momentum it will likely persist for a long time.
Ultimately, to be long term investors we must be avid students of history, even as we must be practical in our day to day and year to year portfolio management. We help clients navigate the trail towards retirement, or restructure a portfolio for legacy, or work to build the scaffolding for growth during their working years. In that work we often remind clients and ourselves that although your goal – accumulation, retirement, legacy - often has a reference date, you (or your heirs) won’t be using all your savings at once. Therefore, while we structure portfolios of meet shorter term liquidity needs, your use time horizon dovetails with your portfolio’s growth time horizon in a way that fundamentally supports having a long-term view – even when markets are volatile.
This is a general assessment of client portfolios and does not reflect the specific circumstance of every client.
1. www.nber.org/cycles.html
2. As calculated by Mackenzie Investments. They define a bear market as a decline of 15% or more.
3. Robert Shiller - http://www.econ.yale.edu/~shiller/data.htm
