In sifting through the piles of accumulated magazines and research papers in my office, I recently came across a Bloomberg Businessweek article titled “As Pessimism Grows, Is It Time to Buy Stocks?” The article was written in September 2010. The first line read, “Americans continue to be wary of stocks.” It went on to mention that investors had pulled almost $57 billion from US stock funds from May to August of that year.
Hindsight tells us that the pessimism was unwarranted. For the five years ended June 30, 2015, the S&P 500 averaged 17.33% per year (data from Morningstar Direct)*.
This got me thinking: without the guidance of a financial advisor, how would our clients have allocated their portfolio at that time? Would they have given in to the negativity that affected many investors and went to cash? Or would they have boldly bet on equities (and stayed invested through the patches of volatility that occurred in 2010 and 2011) and thus fully participated in the raging bull market of the past five years?
Looking back, the approach we took was somewhere between the two extremes of maximum pessimism (100% cash) and maximum optimism (100% S&P 500). On the one hand, we were confident that investing in profitable companies was preferable to low-yielding bonds. On the other, we were wary of the macroeconomic risks associated with large public debt and unprecedented monetary policy. We thought that siding with experienced managers, selecting potentially under-valued companies both in the US and around the world (and willing to hold some cash when they couldn’t find attractive discounts), struck a reasonable balance.
Hindsight bias, or the “I-knew-it-all-along” mentality, allows for easy criticism of a temporarily underperforming investment approach. There is also a strong temptation to abandon the original strategy in favor of what is perceived to be “working”. But the critical question is: what are the odds the next five years will be like the past five, especially considering that since 1926 US large cap stocks have averaged about 10% per year (a far cry from the 17% we have seen recently)?
We think that the concerns we had five years ago were valid then and are still justified. Meanwhile, the S&P 500 index has roughly doubled. This only serves to heighten our aversion to potentially overpaying for stocks, and we continue to believe that maintaining a price-conscious discipline will be rewarded in the future.
We welcome your comments and questions.
Aaron Pettersen, CFA, CFP®