Headline Risk Says Don't Listen to Wall Street on Volatility

There is no sure thing in markets, but high volatility (both upside and downside) for the next two months is pretty darn close! With that in mind, this week’s headline risk comes courtesy of a member of the old institution, Morgan Stanley (MS), says Landon Whaley of Whaley Global Research.

Morgan Stanley wants us to “[Keep] volatility in perspective” when the environment fills with “fear, uncertainty, and a dramatic increase in market volatility.”

In classic old institution fashion, Morgan Stanley believes that “in turbulent markets, it’s important to remember some basic, time-tested principles of investing.” Namely, they think you should “stay invested,” “diversify,” and “maintain a long-term focus.”

Stay Invested

Since the advent of fee-based accounts, the old institution doesn’t get paid when you sit in cash. In fact, if you raise too much cash in your account, your advisor gets tapped on the shoulder by compliance, asking why! The OI needs you invested in stocks, ETFs, mutual funds, and the like because that’s how they get paid.

They want you to stomach the bear market drawdown because if you bail on your investments, it reduces wealth management revenue at a time when their other income streams are drying up. On the investment banking side of the house, fees are down because no one IPO’s or brings a bond offering in the middle of a bear market. In the prime brokerage silo, revenues are faltering because during a bear market, hedges don’t lever up (lower borrowing fees), and they trade less (lower commission revenue).

Morgan Stanley and other OI members will keep you invested even though after a -20% peak-to-trough move, you need a +25% gain to get whole again. If your advisor convinces you to stay in the equity boat and your portfolio gets gutted to the tune of -34% to -51% (which is typical in bear markets), it needs to rally between +52% and +105% to get back to where you started! But I’m sure there’s a reason, beyond fees, for the OI to keep you fully invested during a market downturn, right?

Diversify

A “diversified” portfolio on Wall Street usually takes the shape of a “60/40” portfolio split between stocks and bonds, which the data says is far from helping you out in turbulent times. Looking at the 60/40 portfolio risk during post-World War II bear markets, we see the average drawdown is -20%, while the worst drawdown experienced was -30%.

Holy crap, who in their right mind wants to lose one-fifth to one-third of their capital? Not to mention that if you have to watch your portfolio get the Hannibal Lecter dinner date treatment, you’re not going to feel better just because the S&P 500 declines more.

You can’t spend relative returns, my friends, and you still need a +25%-43% return to get back to breakeven!

As we have discussed on many occasions, a vital and often overlooked aspect of any drawdown is the recovery period following the decline. The average bear market drawdown in the 60/40 stock-bond portfolio erases an average of 47 months’ worth of gains and then takes anywhere from 30 to 50 months to regain the previous high-water mark.

I don’t care who you are or how much money you’ve stashed away; spending 77 to 97 months in a drawdown, and subsequent recovery, is a no-go operation!

Long-Term Focus

“Any investment decisions you make should be based on your financial goals and objectives, time horizon, and risk tolerance, rather than concerns about market volatility.”

I have one question: What’s more relevant to your financial goals, objectives, time horizon, and risk tolerance than the drawdown risk embedded in the market at a given point in time?

Morgan Stanley’s advice continues, “Even if the market seems volatile, remember that ups and downs are normal. It is important to stay focused on your financial future and refrain from making short-term decisions on long-term investments.”

Let me say this succinctly: the only way to reach long-term goals is to make high-quality short-term decisions. Every day, wake up and ask yourself, “Is my portfolio positioned for the most likely economic and financial market scenarios over the next one-three months?” If the answer is “yes,” then do nothing. If the answer is “no,” take action to change the answer. Wash, rinse, repeat.

Wall Street is hoping that if they keep you looking far enough into the future, you won’t notice the fees they are charging while your portfolio (and your psyche) is getting an unnecessary trip to the woodshed.

Bottom Line

The bottom line is that Morgan Stanley, and every other member of the old institution, is not in the business of doing what’s in your best interest. These cats are in the business of keeping you fully invested, no matter the environment ensuring your assets stay parked in vehicles that maximize fee revenue. This fee first focus (say that three times fast) is why they say, “You may be tempted to make major changes to your portfolio in response to market events. However, during these turbulent times it’s important to take a step back and reflect on certain basic, time-tested principles of investing.”

Folks, the only way to manage money during high (or low) volatility environments is to align your portfolio with the prevailing fundamental gravity and let economic and financial market gravity do the rest. 

To learn more about Landon Whaley, please visit WhaleyGlobalResearch.com.