Here are four Safe-Money principles for investing in the age of Covid-19 from Mike Larson....
Is the Bear Your Friend, No, Absolute Returns Are: Part 2
09/20/2019 6:00 am EST
A recent report from UBS suggested that investors are better off riding out bearish markets storms than attempting to trade them. Landon Whaley is taking issue with that, noting absolute returns are the true measure of investing success.
Yesterday, we discussed the recently released UBS Bear Market Guidebook and why we think they are all wet. It’s so bad we need to columns to address it. There are additional the teaching moment it’s providing to us.
After selling the misleading narrative that bear markets are no big deal and stocks go up 67% of the time, UBS then juxtaposes the performance statistics for an all-equity portfolio with that of the standard 60/40 (stock/bond) portfolio during the last seven bear markets.
Clearly, the diversified portfolio fares a great deal better than the U.S. mega-cap equity portfolio. I have just two questions. Are you ever going to be 100% exposed to U.S. mega-cap stocks? More importantly, are you allocating 100% of your hard-earned dollars to stocks when the U.S. economy is in a Fall or Winter Fundamental Gravity, which is when all bear markets occur? No!
It doesn’t matter how the 60/40 did relative to an all-equity portfolio, but UBS concludes part one by asserting that “adding bonds significantly reduces bear market risk, in both pain and duration.” This conclusion falls into the “no s&%t Sherlock” category of insights, but this perspective is yet again one of relative returns rather than the far more critical absolute returns.
Turning away from comparisons and merely looking at the risk for the 60/40 portfolio during post-World War II bear markets, we see the average drawdown is 20%, while the worst drawdown experienced was 30%.
Who in their right mind wants to lose a fifth to a third of their capital?! Not to mention that if you’re watching your portfolio get the woodshed treatment, it’s not going to make you feel any better if the S&P 500 has declined more.
You can’t spend relative returns my friend, and even if you were “lucky” enough to be allocated 60/40 rather than all equity, you still need a 25% to 43% return just to get back to breakeven!
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 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 if you’re a 26-year old millennial who thinks you’re going to live forever. Or if you’re a 45-year old going through a midlife crisis driving your new Founder’s Series Roadster and figuring out how to change the world with the seemingly limited time you have left on this planet. I don’t even care if you’re a 90-year old hoping the next trip to the mailbox will be your last, getting zero return on your money for 77 to 97 months is a non-starter!
This type of “relative return with no attention to absolute drawdowns” swill has been peddled to the masses by the Old Institution since J.P. Morgan first hung his shingle.
The headline risk bottom line for part one is to be a consistently successful investor you must care about absolute returns and the first step towards profiting in any environment is to minimize losses on individual trades and minimize losing years.
Managing losses is critical for two reasons: It’s the only aspect of investing you can control, and large drawdowns eliminate the most potent force in finance, the power of compounding.
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