There's Always a Narrative...

Markus Muhs - Mar 12, 2020
Market volatility doesn't just happen.

I’ve been reading so many good blog posts by top advisors, market strategists, portfolio managers, behavioral investment experts, etc. Follow me on Twitter to see all the good stuff I’m reading. There’s so much good stuff out there to read during markets such as these, so I was wondering if I really even have anything to add. 

I thought I’d share some personal observations and experiences, as someone who started in the industry right smack gab at the beginning of the 2008-2009 bear market. November 5th, 2007 was when I started in a new position at the bank as a Financial Planner, and February 20th, 2008 was when my 90 day regulatory training period ended and I became licensed with the Investment Industry Regulatory Organization of Canada (IIROC) and could start taking on clients and advise them on their investments.

I barely had a handful of clients when the markets plummeted. Globally, they were already meandering from late 2007 through to summer 2008, THEN we had a sharp drop of over 20% after the banking system started collapsing, putting us into “bear market” territory, THEN things got even worse through the fall, with near-1000 point drops on the TSX and Dow (at that time 1000 points was +/- 10%) happening fairly regularly. 

Just before the proverbial crap hit the fan with Bear Stearns and Lehman, I bought my first home. Edmonton real estate prices had already come down substantially from 2007 and I low bid for a condo, waited a while, ended up getting what I thought was a pretty good deal. Not long after that, on what I remember were some cold/windy October days, I made some big expenditures on furniture for my new digs at a point when the markets were getting relentlessly hammered. I started to feel some real buyer’s remorse, for both the home purchase and going a bit overboard with leather recliner couches. That whole period just felt dark, cold, and it’s when I really wondered if the dark future we were entering would even have a place for financial planners.

Going into the new year, I remember feeling not hopeless, but a bit beyond hopeless, to where we were beyond worrying, but just in the midst of a financial armageddon, and there was no picture as to how we would get out of it. Stocks were demolished. Maybe they’ll go up, or maybe everyone who’s selling has run out of things to sell and they can just sit still for a while?. It was “RRSP season” and I have a memory of watching the nightly CTV news in February, and hearing Lloyd Robertson proclaim something along the lines of “Monday is the RRSP deadline and with stock markets crashing, Canadians are at a loss as to where to invest their contributions.” Sounds utterly ridiculous in hindsight, doesn’t it?

The S&P 500 bottomed below 700 on March 9, 2009; a cumulative drawdown of around 55% from October 2007 highs, and a level that it previously hadn’t seen since 1996. Honestly, I remember looking at the longer term charts and pinpointing which year in the early-2000s, and then the 1990s, we had regressed to in terms of index levels. I also kept myself and my clients sane by referring back to an even worse period of time; the lengthy bear market of 1968 to 1982, which I referred to in this post from last summer.

So, what I’m trying to share here is just how utterly hopeless the feeling was that I, and probably other investors, were feeling back then. I didn’t do anything stupid like selling everything in a panic though, and had just 2 (out of, I think around 25) clients who did so against my advice. The stupidest decision I remember doing with my own money was to not invest my brand new $5000 TFSA contribution into stocks at those levels (frightened, I put it into a corporate bond fund instead, which did alright but obviously not as well as stocks from that point forward). Clients too—perhaps heeding Robertson’s advice—were reluctant to invest their new RRSP contributions into the markets, so some of those contributions stayed in cash and even at least one monthly contribution plan was suspended. I was a novice advisor who did what the client wanted; something I've learned over the years isn't always in the best interest of the client...

When we look at the bigger picture, here’s how we ended up. I’m using SPY (SPDR S&P 500 ETF) above to show total return, including reinvested dividends, of a realistically available investment (as opposed to using the index itself) for the 10 years following the October 2007 highs. Obviously, in hindsight, you can see that even if you had the worst luck and invested all your money at the high point prior to the “Great Financial Crisis”,  you did pretty well. If you lucked out and were cash going into it, and invested that cash any time during the draw down, whether at a 20% discount or the full 55% discount, you did tremendously well. In hindsight it looks so obvious. 

Note also, the above shows SPY in $USD terms, which doesn’t take into account the Canadian perspective and why I’m not a fan of hedging to the $CAD, especially for U.S. equity investments. From 2007 to early 2009 the $CAD depreciated from above parity ($CAD was worth more than the $USD, imagine that!) down to 85 cents or so, meaning that the Canadian investor gauging their portfolio in $CAD terms only saw a 30-something per cent drawdown, not 55%. We’re seeing it again today, with the $CAD’s decline from mid to high 70s to low 70s softening the blow a little bit on our U.S. equity investments. The $CAD is a “risk-on” currency, while the $USD is a “risk-off” currency and that’s just wonderful for us Canadian investors who get a little bit of extra risk mitigation built in automatically, so long as we don’t choose to hedge it away.

In hindsight, we’re oblivious to what the narrative was during those “dark times”; what the media was saying, what the so-called experts were saying, the fear-propagation of perma-bears (who are now, temporarily, telling you “I told you so!”)  and other doom-and-gloomers; that general feeling of despair. Thinking back, I almost thought it would be the end of the financial system as we knew it. Would all financial instruments become worthless, would we be SOL if we didn’t have hard assets and canned foods? Credit, which fueled the entire 2000s so far, had gone bust and everybody’s losing their jobs. Where should the economic growth of the future even come from? 

Looking at an even longer term picture, of the past 40 years, we notice a tiny “blip” in the graph in the late-1980s, which occurred during an otherwise strong secular bull market that lasted nearly two full decades. That blip was the 1987 stock market crash that I only heard about growing up and as I was progressing through university and learning about investing. Markets dropped over 20% in a single day in what was termed “Black Monday”. What caused it and what was the feeling on “The Street” at that time? I can’t tell you exactly, I was just starting in the 2nd grade at a new school and had no idea what the stock markets or the economy even were. I can look up some facts on Wikipedia, but so can you. The point being, it was probably also a very dark time and there was some kind of gloomy narrative behind the “crash” and people also couldn’t see tomorrow, and definitely couldn’t see how absurdly inconsequential that blip would look 30-some years later.

So, when we look in hindsight over the long-term everything makes perfect sense when it comes to the markets. They’re always volatile and sometimes very volatile. 20% or greater declines happen with some regularity, 10% or greater declines happen annually, on average. Whenever they went down, they always went up afterward, usually at a faster rate than they were going up before, due to mean reversion. Stocks overall, over the long-term, have rewarded investors with greater compound annual growth than any other asset class, at the expense of greater volatility. If your time horizon is long-term and that volatility does not interfere with your goals, there really is no other logical asset class, other than stocks, to store your wealth in. 

Most advisors do risk questionnaires which pose questions to investors such as what level of market decline they’re comfortable with. These too seem logical; take more risk to get more return. “Of course I’m okay with a 33% drop in a year if it means I potentially can see a 36% rise” OR “I’d rather limit drops to 20% and am okay with less of an upside”.

What none of the above considers though, neither my historical charts nor risk questionnaires, is what the narratives are/were during declines? That’s what I’m getting at, with the title of this blog post. THERE’S ALWAYS A NARRATIVE. Extreme volatility is a feature of the marekts, not an exception, but there’s always some really scary stuff behind those declines; they don’t just happen randomly. How gloomy is reflected in how much and how fast and how far the market dropped, and when you’re in the middle of that gloom, as I was back in early 2009, you see no tomorrow.

Today that gloom is obviously the Coronavirus, which has just been declared a global pandemic literally as I write this, and its potential effects on the economy. I don’t want to debate or speculate about it, but let’s just take the perspective of the gloomiest outlook: if the virus spreads at the same rate that swine flu did (also in 2009), from its current infection rate of 0.002% of the world population, to infecting a few billion, it could potentially kill over 100 million mostly elderly people (to put into perspective, the ordinary death rate of the world is around 60 million people per year, so let’s call it a doubling in annual deaths). More than the toll on public health, the economic worry is the effect of global social distancing; a temporary cessation of most travel, gathering at events, and large numbers of people going into self-isolation when deemed at risk of being or having been in contact with a carrier. That’s the gloomy scenario we’re in now, reflected in today’s markets.

When we look back, maybe 10 years hence, at the stock markets of 2020, we’ll see a line. I don’t know yet what that line will look like, but I doubt that line will have any effect on day to day life in 2030, nor what the stock market valuations are at that time. Will we look back at that line and say “that was a fantastic time to invest” and when we observe the “blip” (or outright canyon) in the line will we see it as just a feature of the markets, normal volatility? Will we even remember just how gloomy things were?



Images above sourced from Thomson One, Morningstar, and Naviplan.