What is causing all the crazy market swings (part 2)?

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Welcome back.  Last week I started listing off reasons we’re seeing so much more volatility in the stock market. In this blog I’ll take you home.

 “Skynet becomes self-aware at 2:14 a.m. Eastern time, August 29th.” –Terminator 2 (1991)

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Computer-initiated trading drives a major, and increasingly larger, portion of the volume in stock markets.  It’s a good thing for a few reasons.  It gives people more options in their trading strategies, it offers precision that humans can’t match, it doesn’t get tired or forget or anything like that.  But it also leads to a lot of volatility.

One of the major types of automated trading is “stop-loss” trades.  This is when someone owns a stock like Nike and says something like: “I only want to sell it if it starts to fall.  Right now the stock is at $50, so sell it if it goes below $45.”  Emotionally it makes sense.  Everyone knows crazy things can happen with stocks and it can all go to hell in the blink of an eye (see: Enron or Worldcom or Blackberry).  So as the name implies, this stops your losses at some level you establish.  Awesome.  You have more control.

The reason this increases volatility is that this type of trade tends to compound the problem.  When stocks are going down these stop losses trigger which sells more stock which drives the prices down further which triggers more sell orders and so on and so on in a downward spiral.  The obvious flaw is that the computers which are doing this don’t have any idea of the intrinsic value of the stock they are selling; they just know they are supposed to sell when the stocks hit a certain level so that’s what they do.

When rational humans look at these types of situation (maybe like Boeing on July 12) and can “see” that the market is overreacting, things tend to go back to levels that make sense.  Probably the best example of this is the Flash Crash of 2010.  On May 6 of that year, probably the craziest 30 minutes ever of stock trading occurred.  In a matter of minutes the market fell about 10% (equivalent to about 1700 points on the Dow Jones Industrial Average if this happened today!!!), and then just as quickly recovered nearly all the loss.

What made it so crazy was that no news drove it.  Maybe news of a nuclear war starting or a meteor on a collision course for earth would justify such a rapid move.  Of course there wasn’t that, but there wasn’t anything—no news from the Federal Reserve, no companies going bankrupt or countries defaulting on their debt, or a regional skirmish, or a refinery blowing up, nothing.

In the aftermath, the leading theories all ultimately pointed to automated trading.  Some sell order lowered prices slightly but just enough to started triggering stop-loss orders.  That started a selling frenzy that drove prices down, leading to more stop-loss orders and in an instant everything went to hell.  Once thinking people saw this and knew that something weird was going on, they started buying those shares which were selling at 10% or 20% or even 50% less than they were 20 minutes before and made things normal again.  Like so many examples here, we ended where we started, but we had a crazy ride in the meantime.  More volatility.

“We keep inventing better ways to kill ourselves”

The stock market is an evolving landscape.  There was a time long, long ago when it was just stocks.  Then derivatives like options and futures came along as well as buying on margin (borrowing money to buy your stock); and now we have stuff like credit-default swaps (I can’t say I fully understand those), virtual currencies, and other really exotic things.  Like a gun or a power saw or a car, these financial tools can be very useful when used correctly but they can be disastrous when used recklessly.

Generally speaking these investments lead to higher volatility because they tend to be very leveraged.  You can make really, really large investments without a lot of money.  To buy 1000 share of Medtronic would cost you about $75,000; but to “buy” that same amount using call options would cost maybe something like $2000.  Of course, derivatives like stock options are much more volatile, and can lose all their value really quickly.

All the sudden that means you can be a small-time investor who decides to throw a Hail Mary in the stock market.  Instead of needing a bunch of money to take a major position, you could do it with much less.  Realistically, I as an individual probably couldn’t take such a big position to impact the market, but certainly a small bank could.  There are dozens of stories where some trader at a bank took a crazy big position, often times using derivatives, that went bad.  Not only does it take the bank down, but when that bank falls, just like dominos, others fall with it.  Same story: increased volatility.

So we’ve covered a lot of ground and come up with a lot of things that make today’s stock market much more volatile than it’s ever been in the past.  But let’s remember that the stock market is ultimately about fundamentals.  How strong are the companies?  Are they coming up with new products?  Are they finding better, faster, cheaper ways to meet our needs?  Those are the things that make the stock market go up over time.  And I believe all those things are there in today’s stock market.

In fact, of all the reasons I cited for increased volatility, I think all of them are good for the long-term value of the stock market.  Information traveling faster is a good thing; a globalized economy is a good thing; computer assisted trading is a good thing; financial derivatives are a good thing.  They’re all good and they all are making stocks continue to be a good investment.  Remember, stocks have been on a relentless climb for over a century.  In 2015, despite all the craziness, we were still hitting new all-time highs.

Sure, sometimes people screw things up, and because of this new age, those mistakes make a big impact.  But that big impact fades, usually very quickly.  So Mimi, as always, I think the stock market has great prospects for the long-term future, and I’m putting my money where my muzzle is on this one.  Your daughter-vixen’s retirement money as well as your grandcubs’ college funds are fully invested.

What is causing all the crazy market swings?

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A couple years ago, th I did an a analysis that showed that the stocks market has gotten MUCH MORE volatile in recent years. Since then, it’s gotten even worse. That begs the question–why has the stock market gotten so much more volatile?

“Ready, Fire, Aim” –Tom Peters (1982)

Nearly everyone agrees that information is the lifeblood of the stock market.  Today, that information travels so much faster than in the past.  Something could happen in the most remote corner of the world, and you would know about it in everywhere in a matter of seconds or minutes.  Obviously quicker access to news is a good thing for society at large, and investing in particular, but it definitely exposes many investors to making big mistakes because they are acting so quickly.

marquee-787

A good example is July 12, 2013.  On that day a Boeing 787 caught on fire a Heathrow Airport in London.  Here’s some quick historic context: the 787 was Boeing’s next generation aircraft that was going to revolutionize air travel, a plane Boeing pretty much staked its entire future on.  In early 2013 two 787s caught fire, leading to the FAA and its counterparts around the world to ground all 787s until Boeing figured out the problem.  Boeing’s stock, as you would expect, got hammered.  It took Boeing several months, but they fixed the problems, got the 787s in the air again, and their stock recovered.

Then July 12 happened.  News broke that another 787 caught on fire.  Investors, understandably, concluded that the problems weren’t fixed after all and that the planes would be grounded again.  In a matter of minutes the stock cratered, falling from about $108 per share to $99.  Over the following hours and days, it became clear the July 12 fire had nothing to do with the previous problems; it was just one of those things that do happen every once in a while.  No big deal.  Two weeks later, Boeing’s stock was back to the pre-July 12 fire levels.  It was all like nothing happened; except it did happen and there was crazy volatility in the stock.

The morale of the story is that investors got the information so quickly and rushed to act on it so quickly, that they completely misevaluated the situation, and that led to a lot of volatility.  Had the news traveled more slowly, the world would have had more time for more of the facts to come out.  No matter how you slice it, the light-speed fast news makes the pace of investing faster, and when you do something faster, you tend to make more mistakes.

 “The chief business of the American people is business” –Calvin Coolidge (1925)

UNITED STATES - AUGUST 03: Official Portrait Of Calvin Coolidge On August 3, 1923, Then Vice President Who Succeeded Harding As President. He Was Elected In 1925. (Photo by Keystone-France/Gamma-Keystone via Getty Images)

We Americans are probably a bit spoiled.  There have been no wars fought on our soil since 1865 (I didn’t count Pearl Harbor, which reasonable people can debate).  There has been a consistent government since 1787 (or 1865 depending on how you think about the Civil War) without any coups or revolutions.  There’s never been a military takeover of the government, and the US government has never defaulted on its debt.  You could go on and on.

The reason that is important is that today about one third of all earnings in the S&P 500 come from outside the US.  It’s hard to find out what that number was in 1950 or 1960, but suffice it to say that that number was much, MUCH lower back then.  So we have a lot more international exposure now than in the past.

That’s a good thing because of diversification.  But it does expose us as investors to some of the geopolitical challenges that I just mentioned, that the US has been blessed to have avoided.

Also, to President Coolidge’s quote, the US tends to be oriented towards business (and some, but not I, would argue too oriented towards business).  This has definitely helped us become the largest and strongest economy in the world.  But other countries have other orientations (I’ll try not to use too blatant of stereotypes to offend my international readers): the Middle East is very theocratic, Japan focuses on saving face (keeping it from writing off bad debts which has stalled its economy for two decades), China is very authoritarian, Europe is more socialistic.  That doesn’t mean any of those other perspectives is bad.  But it does mean they are less likely to drive greater business and productivity, and those are not good if your goal is to have your stocks grow.

If you’re exposed to those geopolitical landmines as well as those competing priorities, it shouldn’t be surprising that the road won’t be as smooth.  And that’s just French for saying more volatility.

“The world is getting smaller” –Mark Dinning (title of a song from 1960)

Somewhat related to the above issue, the world is getting smaller (don’t think the irony is lost on me that a phrase we use to describe how fast the modern world is changing came from a song two decades before I was born).  Everything is so much more connected now, whether it be products (your car is connected to the internet which depends on satellites and under-water fiber optic cable) or countries (the components for your phone probably came from a dozen different countries).

All that interconnectivity is a good thing.  It means people/companies/nations can specialize in what they do best, allowing us to get the best products and services at the lowest prices.  But that connectivity also means that when the stone falls in the pond in one part of the world, the ripples hit everyone in some way, big or small.

Back in the day when the US economy was largely self-reliant, and even local economies were fairly independent, if crazy stuff happened across the world or even across the country, it didn’t affect things at home that much.  That impacts volatility because something is always going crazy somewhere.  And of course, that carries over to stocks which react to that craziness.  Gone are the days when General Mills was a regional foodstuffs provider for the Midwest; now its stock is affected by the Los Angeles longshoremen striking, the drought in sub-Sarahan Africa, and the revaluation of the Argentine peso.  Once again, more volatility.

This seems like a good stopping point.  Come back on Monday, same fox time, same fox blog, for the exciting conclusion to “What the hell is going on in the stock market?”

When does it go from gambling to investing?

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I’ve done a ton of posts on how over time stocks are a great investment, and I absolutely believe that.  However, like with all things, if you look at the extremes you start to see funny results.  Particularly, over the very short term, stocks aren’t really good investments at all.  In fact, if you “invest” in stocks and have a really short time horizon, you aren’t investing at all but rather you are gambling.  So investing or gambling, what’s the difference?  And when does stock ownership switch from gambling to investing?

As always, this is when I nerd out and get my handy dandy computer and free data from the internet and see what the numbers say.  Hopefully it’s not surprising that the longer you hold on to an investment, the lower the probability that you lose money.  But it is interesting how the numbers work out.

On any given day, there is a 46% chance that stocks will go down.  That’s not quite a flip of the coin (since stocks go up over the long run, you’d expect them to have more good days than bad), but that’s pretty darn close.  So let’s agree that if you’re investing for only a day, then you’re gambling.

Graph

Obviously, you can contrast that with the other end of the spectrum where historically there hasn’t been a 20 year period where you would have lost money.  0% chance of losing is not gambling, that’s clearly investing.

So where do you draw the line?  If you move from a day to a week, the chances of you losing money drop from 46% to 43%.  That’s a little better, but that still feels like a flip of the coin to me.  Go from a week to a month, and the chances of you losing money drop a little bit more, down to 40%.  It’s going in the direction that you would expect—probability of losing money drops the longer you hold on to the investment—but we’re still squarely in gambling territory.  If you do something and there’s a 40% chance of it coming out bad, I definitely don’t like those odds.

You can follow the table and see that at 5 years, the chances of you losing money on stocks is about 10% and at 10 years it’s at about 2%.  Clearly there is no right answer, and this is an opinion question so everyone is different, but I figure that somewhere between 5 and 10 years is when purchasing stocks ceases to be a gamble and starts being an investment.

Recreational investing

One of the things I try to do with this blog is help people better understand the stock market and how it behaves by looking at historic data.  I think this is a good example.

As I said at the start, the stock market is a great place to build wealth but you have to be smart about it and you have to have your eyes wide open.  If you’re investing just for a month or a week or a day, just understand that what you’re doing looks a lot less like investing and a lot more like gambling.  If that’s what you want to do that’s great.  Just be honest with yourself.

This brings me to an interesting topic which is “recreational investing”.  A lot of people come up to me and say they understand that slow and steady, and index mutual funds, and a long-term view are probably the best way to build wealth.  But it’s boring (a sentiment I totally agree with), and they want to keep a small portion of their money so they can “play,” investing in particular stocks they like, similar to the way someone would pick a horse at the track or play the table games in Vegas.  To this I say: “go for it”.

Life is too short, and that stuff can be really fun.  If it’s fun for you to “play the market” and gamble on some stocks, rock on.  Just know that you’re gambling and not investing.  But I’ll tell you, if you have a gambling bug, I’d much rather do it with stocks than blackjack or the ponies.  With stocks, as we saw above, even over a short time frame, you have the “house advantage”.  With other types of gambling, the house has the edge.  So I totally support recreational investing if that’s what you’re in to.

What do you think?  At what point does buying stocks change from gambling to investing?  I’d love to hear.

Should you invest in gold?

Long before there were ever stocks or bonds, the original investment was gold.  Heck, even before there was paper currency or even coins, gold was the original “money”. 

That begs the question, What role should gold have in your portfolio?  If you don’t want to read to the end, my quick answer is “None”.  However, if you want to have a bit of a better answer, let’s dig in.

Gold as an investment

Just like stocks and bonds, gold is an investment.  The idea is to buy it and have it increase in value.  Makes sense.  And historically, it seems to have been a good one—back in 1950 an ounce of gold was worth about $375 and today it’s worth about $1300.  Not bad (or is it???).

However, there is a major difference between gold (and broadly commodities) as an investment compared to stocks and bonds.  Gold is a store of value.  If you buy gold it doesn’t “do” anything.  It just sits in a vault collecting dust until you sell it to someone else.

That’s very different from stocks and bonds.  When you buy a stock that money “does” something.  It builds a factory that produces stuff or it buys a car that delivers goods or on and on.  What ever it is, it’s creating something of value, making the pie bigger.  That is a huge difference compared to gold, and it’s a huge advantage that stocks and bonds have over gold.  You actually see that play out by looking at the long-term investment performance of gold versus stocks.

Golden diversification

Statistically speaking, gold gives an investor more diversification than probably any other asset.  We all know that diversification is a good thing, so this means that gold is a great investment, right?

Well, not really.  Stick with me on this one.  Gold is negatively correlated with stocks (for you fellow statistics nerds, the correlation is about -0.12).  Basically, that means when stocks go up gold tends to go down, and when stocks go down gold tends to go up. 

Over the short term, that’s probably a pretty good thing, especially if you want to make sure that your investments don’t tank.  In fact, that’s one of the reasons gold is sometimes called “portfolio insurance”.  It helps protect the value of your portfolio if stocks start falling, since gold tends to go up when stocks go down.

However, over the long-term, that’s super counter-productive.  We all know that over longer periods of time, stocks have a very strong upward trend.  If gold is negatively correlated with stocks, and if over the long-term stocks nearly always go up, then that means that over the long-term gold nearly always goes (wait for it) . . . down.

That doesn’t seem right, but the data is solid.  Look back to 1950: an ounce of gold cost $375.  About 70 years later, in 2019, it’s about $1300.  That’s an increase of about 250% which might seem pretty good, but over 70 years that’s actually pretty bad, about 1.8% per year.

Contrast that with stocks.  Back in 1950 the S&P 500 started at 17, and today it’s at about 2900.  That’s an increase of about 17,000%, or about 7.7% per year.  WOW!!!

Just to add salt in the wound, inflation (it pains me to say since I think the data is suspect) was about 3.5% since 1950.  Put all that together, and gold has actually lost purchasing power since 1950.  Yikes!!!

A matter of faith

Fundamentally, if you have faith that the world will continue to operate with some sense of order, then gold isn’t a very good investment.  So long as people accept those green pieces of paper you call dollars in exchange for goods and services and our laws continue to work, gold is just a shiny yellow metal.

However, if society unravels, then gold becomes the universal currency.  The 1930s (Great Depression), the 1970s (OPEC shock), and 2008 (Great Recession) were all periods where gold experienced huge price increases.  Those are also when the viability of the financial world order were in question.  Each time, people were actively questioning if capitalism and banks and the general financial ecosystem worked. 

People got all worked up and thought we were on the brink of oblivion.  Gold became a “safe haven”. People knew no matter what happened, that shiny yellow metal would be worth something.  They didn’t necessarily believe that about pieces of paper called dollars, euros, and yuans.

Yet, the world order hasn’t crumbled.  Fiat currencies are still worth something.  Laws still work, so that stock you own means that 1/1,000,000 of that factory and all it’s input belongs to you.  Hence, gold remains just a shiny, yellow metal.  

The bottom line is that stocks have been a great long-term investment, and gold hasn’t.  And that’s directly tied to the world maintaining a sense of order.  So long as you think that world order is durable and we’re not going to descend into anarchy Walking-Dead style, then gold isn’t going to be a good investment.

So the survey says: “Stay away from gold as an investment in your portfolio.”

Top 5 Reasons We’re in the Golden Age of Investing

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You hear all the time that this is a terrible time to be an investor.  Maybe it’s after the fallout of some scandal, Enron and Worldcom from the early 2000s or Bernie Madoff from 2008 come to mind.  Or maybe it’s that the market is evolving and people caught on the wrong side of that start to complain.  A while back Michael Lewis published Flash Boys which looked at high frequency trading.  One of the takeaways was that Wall Street giants were rigging the game to their advantage at the cost of smaller investors.

flash boys

Of course, it wasn’t limited to Michael Lewis. We seem to be constantly barraged with stories about how investing is terrible now, the odds are stacked against the little guy, the fat cats are taking advantage of everyone.

I’m not an expert on high frequency trading or the million other death knells that people always point to when showing that the market is all screwed up.  The eternal optimist, I actually think this is a great time to be an investor.  Here are my top 5 reasons why we are in the golden age of investing.

5. Decimal stock prices: Today if you look up the price for a stock you get something normal looking like $40.63. However, before 2001, stock prices were quoted in fractions, so that same stock wouldn’t be $40.63, it would be 40⅝.  First off, that was a royal pain the butt.  Quick, which would cost more $20.30 or 20⅜? (20⅜ is more).  We all remember fractions from elementary school, but they aren’t really intuitive in financial applications.

Secondly, it cost you real money.  All stocks have a bid/ask spread which is the difference between what someone will sell something for and what they will buy it for.  That difference is the profit that market makers get.  As an investor you pay that spread, so the larger the spread the worse for you and the better for them.  When stocks were in fractions, just the nature of fractions made the spread fairly large.  So you might have an bid of 20⅜ and an ask of 20½.  That’s a spread of 12.5 cents for every share you trade.  That may not seem like a lot, but over hundreds or thousands of shares that starts to add up.

When stocks became decimalized, that 20⅜ became $20.38 and that 20½ became $20.50.  But then competition among market makers squeezed the spread to something like $20.41 and $20.42.  It’s not uncommon to see spreads of only a penny (see a recent quote I pulled up for Medtronic).  That is real savings that goes into your pocket.  In 2001 the SEC mandated all stocks be quoted in decimals and that was a real win-win: investing became computationally easier and less expensive.

Medtronic chart

4. Internet trading: You could have a whole post on how the internet has revolutionized personal finance (hmmmm, maybe I’ll do that). But here I’ll focus on internet trading and generally managing your investments online.  When I started investing in the mid-1990s the main way you invested was by calling your broker and having her execute the trades you wanted.

Think about that for a second.  You had to call someone, hope they answered, tell them what you wanted to do, and then have them do it.  That just seems really inefficient.  Later, some mutual fund companies got to the point where you could trade using your touch-tone phone (“press 1 to buy shares, press 2 to sell shares”), but even that was pretty kludgy.

Of course, once the internet came out, investing proved to be one of the ready-made applications for cyberspace.  You could actually see your investments on a screen, in real time, push buttons to do what you wanted.  Even set up things like automatic investments or withdraws.  No question, it’s so much easier now than it was.

3. Low costs: With the internet and the incredible efficiency it brought, the costs of investing plummeted. Brokerage fees on some of my first trades were in the $50-75 range.  That was with a full-service broker.  Also there were ways that they nickel-and-dimed you with things like “odd lot hikeys” which was an extra charge if you bought less than 100 shares.  Such a bunch of crap.

That was about the same time that “discount brokers” were becoming popular and started offering internet trades for $14.95.  Once that genie got out of the bottle, there was no end to how low trades could go, and it made sense.  All the stuff became automated, so the costs dwindled to almost nothing.  Now you can find $4.95 trades and places like Vanguard offer $2 trades if you know where to look.

Think about that for a second.  If you did 10 trades a year, in the old days (dang, that makes me sound old) that would have cost you $1500 per year (remember you get charged for buying and selling).  Over an investing career, that $1500 each year could add up to almost a quarter of a million dollars!!!  Maybe Michael Lewis will complain that investors are getting swindled out of a penny or two a share because of high-frequency traders, but that’s a drop in the bucket to what they’re saving by tiny, tiny trading costs.

2. Computing power: As reader Andrew H said in a comment, technology has advanced so rapidly that your iPhone has much, much more computing power than the Apollo 11 spacecraft. Computing technology has become amazing powerful and amazingly cheap in the past couple decades.  A $300 laptop with Excel can allow you to do amazingly large and complex analyses that would have seemed magical just 30 years ago.

One of the huge applications for this analytic power is personal finance and better understanding the stock market.  Many of my posts on this blog are just that—taking data and using Excel to make sense of stuff.  Are you better of investing a windfall at once or over time?  How often would you have lost money in the stock market historically?  Those are fairly large analyses that would have been a massive undertaking 30 years ago, probably only possible at a major investing house or a university.  Today, they’re done by a nerd with a cheap computer and too much time on his hands.

That computing power has been an amazing equalizer on the financial playing field.  Now individual investors can figure things out for themselves instead of having to listen to brokers like they were priests from some secretive cult.  That’s an enormous improvement.

1. Access to information: This is a biggie. The amount of information available to us now with the internet is mind-boggling.  When I was a kid your source of information on stocks and investing was the evening news (“stocks were up 52 points today”) and the newspaper where you could look up the price of a stock from the previous day.  That was it???  That was it!!!

Today you have real-time price quotes, you have real-time news, you have real-time analysis.  You also have troves of data, and nearly all of it is free.  All the analyses I have done is with free data on historic stock prices and inflation.  That’s nice if you’re a dork like me, but how does this help normal people?

In investing, information is power, and we live in a time where that power is freely given to all.  Let’s say you wanted to invest in Ford in 1990.  How would you go about researching your investment decision?  Maybe call Ford’s investor relations to have them mail you some annual reports, possibly go to the library to find some articles on the company, probably stored on microfiche.  That’s crazy.  Today you can find all that information plus about 1000 times more in less than 5 minutes on your computer.  It truly is a completely different ballgame, and one that is very much to our advantage compared to what it had been.

Bonus reason—financial understanding:  I couldn’t stop at five reasons, so I am including a sixth (the “Top 6” just doesn’t have the same ring).  There has been tremendous research into financial markets and how they behave over the last couple decades.  While markets are still very unpredictable by their nature, we understand them much better.  Ideas like price-to-earnings ratio, index mutual fundsefficient markets, and a thousand others help us better understand how and why the stock market does what it does and that allows us to be better investors.

In a similar vein, the central bankers who guide our economy, and by extension the stock market, have learned a lot too.  One of the theories on why the Great Depression was as bad as it was is because President Hoover and his advisors did all the wrong things.  It’s not that they were vindictive and wanted to drive the country into a calamitous financial train wreck, but they just didn’t know what to do.

I absolutely believe the reason we haven’t had another Great Depression, including the Great Recession where we emerged largely unscathed, is because our central bankers are a lot smarter.  Paul Volker, Alan Greenspan, Ben Bernanke, Janet Yellen, and now Jerome Powell all studied the Great Depression and other financial disasters and learned what those people did wrong and how similar fates can be avoided in the future.  That understanding has saved us a lot of pain.

So there you have it.  Sure, investing isn’t always a smooth path, and as Michael Lewis points out, there are always bad apples that are trying to screw things up.  But with all that, don’t lose sight of the fact that investing today is soooooooo much better than it has ever been before.

What do you think?  Are my glasses too rose-colored?  Are there other awesome developments that deserved a place in the top 5?

Will you lose money with stocks?

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This is probably the most common question you get from people who are considering starting to invest in stocks.  It’s pretty understandable; you work hard for your money and the idea of it disappearing into the black hole of an unpredictable and often times not-well-understood stock market is pretty hard to stomach.  Add on that scars from the 2008 Great Recession, 2001 Internet Bubble, Black Monday in 1987, Black Tuesday in 1929, and on and on and on.  Even recently, 2018 has had a bunch of wild freefalls, including the one we’re in right now.

So, what’s the answer to the question:  Who knows?  The stock market is unpredictable and no one knows what will happen in the future.  That’s not an especially satisfying answer, but it’s the truth.  If I could predict the stock market I would own my own island in the Caribbean next to Johnny Depp’s.

But I can hear you saying, “Come on, you’re Stocky Fox.  You can do better than that.”  You’re right.  I’m taking on the challenge and answering the question: Will you lose money with the stock market?

I won’t try to predict what will happen in the future, but I think you can look to how things have behaved in the past, and get a pretty good perspective.  Of course, there’s no certainty that the future will be like the past, but that’s the best we have to look at.

You can get somewhat decent data on the stock market going all the way back to 1871.  Back then, your great-great-great grandmother was getting The Stocky Fox as a newsletter delivered by the Pony Express.  Going that far back, you can calculate the percentage of the time that you would have lost money investing, historically.

So imagine starting in January 1871 and investing $10 every month in the US stock market.  By January 1872, you would have invested a total of $120 and your stocks would be worth $128; congratulations, you just made a profit.  You can do that for every 12-month period since 1871 (there are about 1700 such periods), and you come out ahead 71% of the time, which seems pretty good.  But the flip side is that you’d have lost money 29% of the time, and at least to me that is too high to be really comfortable.

Chart for losing money

However, remember that when investing stocks, time is on your side.  Do the same exercise but for five years; if you started in January 1871 after 5 years you would have invested a total of $600 which would be worth $679 in January 1876 (yeah, profit again!!!).  Do that for every five-year time period and you end up losing money only 13% of the time.  By adding another four years to your investing time horizon that decreased the chances that you would have lost money by 20%!!! That seems pretty amazing.

You can keep doing that for longer time periods, and as you could guess, the percentage of times you would have lost money keeps going down.  Astoundingly at the 20-year mark, you would have lost money only one time out of the nearly 1500 periods possible (the one month was June 1912 which, you guessed it, was 20 years before the Great Depression bottomed out).  At 30 years, there isn’t a single time period where consistent investing would have lost money!!!  That’s not a misprint.  Read that paragraph again.

There are no guarantees, but if you use history as a guide, it’s pretty much a sure thing that you’ll make money in the stock market.  Certainly it involves a lot of discipline, investing month after month no matter how bad things look (dollar cost averaging).  Also, it doesn’t necessarily mean you always make a lot of money, but the data seem pretty powerful.  Additionally, I didn’t take inflation into account so that would definitely skew the numbers downward (but you know how I feel about the integrity of the data on inflation, so there you go), but the message remains largely unchanged.

I must confess that I was a bit surprised by the data.  Actually, I spent about 30 minutes going through the spreadsheet to see if I made any mistakes; I’m pretty confident the analysis is sound.  As Dr Brown asked Marty in Back to the Future, “Do you know what this means?” (just don’t take what he says after that and apply it to my analysis).  If your time horizon is 20 years or more, at least based on history, there’s virtually no chance that you’ll lose money.  I figured it would be a pretty low chance, but zero chance?  I didn’t see that coming.  Even people who invested for 20 years then pulled out after the Great Recession in 2008 did fairly well (invested $240 which became worth $339).

So there you go.  My answer to the question posed at the top is still: No one knows what the future holds.  But the historic data confirms my personal belief that the stock market is a really great place to invest your money.  I lose no sleep worrying about the Fox family’s investments increasing in value.  I know over the long term they will.

My story about selling commodities

A few years ago, I wrote about our worst investment of all time—commodities.

I think this is a classic case of deviating from the tried and true rules that you only need three investments in an effort to get creative and get higher returns.  In general you should always resist that siren song.  It cost us well over $100,000; that’s an expensive lesson.

After a few years of crapping performance, I finally bit the bullet, admitted defeat, took a huge loss, and sold my commodities.

 

Examining the wreckage

We starting buying commodities ETFs (ticker symbol DJP) in 2010 in small increments, and continued that through the end of 2014.  When all was said and done, we had invested a total of about $100,000.  By the time we sold, those ETFs were worth about $65,000, so we lost $35,000.  Ouch!!!

But that’s only a small part of the loss.  I knew, I KNEW, that we should invest that money in stocks but we didn’t.  Had we invested that money in a stock index fund that $100,000 would have grown to nearly $200,000 by the end of 2017.  I just threw up in my mouth.

A picture says a thousand words–the purple line is commodities for the period we owned them; the blue line is US stocks. OUCH!!!

 

This is a boneheaded mistake for the ages.  Of course, as in most things in life, when you realize you made a mistake like that you need to move on.  With stocks that’s tough psychologically to do because not only is it admitting failure, but it’s also locking in those losses.  So long as you keep the investment you can always tell yourself there’s a chance that things will turn around.

Finally at the end of 2017, to take advantage of a little tax loss harvesting, I sold all our commodities investments.  That horrendous chapter of our investing history was over.

 

Investing gods decide to humble me further

What unfolded was a story similar to one of those stories from the Bible where God continues to test someone’s faith.  I sold all our commodities investments and invested them in US stock investments.

By the end of April 2018 commodities were up about 2% for the year while stocks were down 2%.  ARE YOU KIDDING ME?  After 7 years of stocks drastically outperforming commodities, the trend reversed right after I sold out my commodities.  As you might guess, I was feeling picked on by some power beyond my understanding.

I kept to my guns and my faith was rewarded.  By the end of August 2018, stocks had a big rally (up 8% for the year) while commodities were crushed (down 7% for the year).  When all is said and done, stocks are up about 2% while commodities are down 5%.  That difference equates to about $4000 in my favor.

 

There are a couple things I took away from this:

First, as an investor, you have to focus on the present and future, and not cling to the past.  Second, sometimes your investments work out and sometimes they don’t, and you can’t get paralyzed by your investing failures.  Third, exotic investments generally don’t work out over time.

All these really combine to illustrate all the things I did wrong with commodities.  I should have just stuck to investing in stocks as I always preach on this blog.  Once it started going bad, I should have cut and run instead of clinging to something in the hope that it would “come around.”

Better late than never.  While I definitely left over $100,000 on the table, at least I didn’t leave that last $4000.  That’s what I tell myself anyway.

Top 5 investing highlights from 2018

We’re all getting used to me going for extended periods without writing a blog post.  I’m sorry about that, but I’ve had a consulting job for the past couple months that has been keeping me busy.  It’s starting to wind down, so I should have more time to consistently write posts.  As always, thank you for sticking with me.

 

Wow!!!  It’s been a crazy few months in the stock market since I’ve been gone.  I figured for my first blog back I would give you my list of the craziest/most interesting things to happen in the investing world the past few months.  Some of these deserve their own post, so we can dive deeper into those in future posts.

Without further adieu, here are my Top 5 investing highlights since April:

 

5. Interest rates on the rise: 2018 has been the year of the interest rate increase by the Fed. In response to the 2008 financial crisis, the Fed cut interest rates to nearly 0%.  There they stayed for nearly the entire 8 years of the Obama administration.  It was only in December of 2015 that the interest rate was raised to 0.5%.

Since 2015, there have been 7 rate increases (including 3 so far in 2018), bringing the Fed rate to 2.25%.  This stuff makes finance nerds giddy, but it does have real-life impacts on the rest of us.

I think the biggest direct impact is that mortgage rates have started to go up.  Now a 30-year fixed mortgage is at about 5%.  A couple years back it was at 3.5%.  That’s a major change that could mean hundreds of dollars per month on a families mortgage.  This impact stretches to housing affordability (gets worse) and number of families refinancing (goes down).

 

4. Massive tax law passes: I know the big tax law passed in December 2017, but I feel a lot of the ramifications hit in 2018. By mid-year it seemed the impact was starting to hit the market—GDP growth was higher than it had been in a really long time, unemployment was lower, and because of the low unemployment inflation had kicked higher.

The immediate impact of the tax break had a major boost to the markets in late December and early January.  Then there was a huge market drop in late January and early February.  However, it seemed that the benefits of the tax breaks (higher GDP, lower unemployment) started boosting stock, with the US markets hitting all-time highs in September.

Obviously, since September stocks have been on a major slide, but we’ll leave that for reason #1.

 

3. US elections in November: Politics are different from investing, but obviously they are connected. The soap opera that is Washington DC hit a fever pitch on November 6, with an unusually high amount of drama for a off-election.

Republicans increased their majority in the Senate, while Democrats gained enough seats in the House of Representatives to take over that chamber of Congress.  The headline was obviously that the US would have a split government for the next two years.

Pundits spent innumerable hours debating the impact split government would have on the nation broadly and the investing markets in particular.  The common thinking is that split government is a good thing in that government can’t make major changes, giving some level of predictability for business.  I tend to agree with that.  In fact, when you look at the data, the stock market does best with a split government.

In case you were curious, the market was up 2.1% the day after the elections, so clearly the markets liked the outcome of the election.

 

2. America is #1: I had a blog on this a while back, but I’m still fascinated by this phenomenon. As of now, US stocks are down 2.2% for the year while international stocks are down 14.2%.  That’s a 12% difference!!!  That’s huge!!!

Curiously, they stayed fairly coorelated all the way through April.  Then, starting in May, they really began to diverge.

The reasons aren’t entirely known.  Many people have many opinions, and I imagine this will be examined for years.  However, my belief is it’s a combination of the US winning the trade wars, China’s economy slowing down, and Europe figuring out Brexit and the future of the EU.

Who knows if I’m right or wrong.  But certainly this is interesting.

 

1. The rollercoaster that is the stock market: It has been a wild ride all of 2018.

January started out on fire, then the stock market took a huge dump in February, rallied towards the end of the month, fell again in March, then plodded out a 8-month upward march that peaked in September, and has since fallen to its current levels.

Those a 6 distinct moves, all of which are major.  I’ve talked about how I think volatility is becoming more inherent in the market, so I think that’s a piece of it.  But the change of directions this dramatic is definitely an unusual twist.

And we still have a month to go.  Stay tuned.

Market dips are awesome?!?!

Holy crap!!!  The last week of the market has been insane.  We’ve seen the largest point drops in the history of the Dow—1175 drop on Monday and 1033 drop on Thursday, although neither ranked within the worst 50 drops in percentage terms.  This is crazy, yet why would I possibly think that this is a good thing?  Over the past 6 trading days, the market is down about 7%.  Yowza!!!

I am, and most of you are, long term investors.  The money I am investing in the stock market is meant to be spent years, or more likely decades, from now.  Sure, what happened right now sucks and maybe is scary (although I think it’s actually the opposite).  That should be comforting because, although we’ve taken a huge body blow, the good news is that we have a really long time to recover.

 

Dollar cost averaging

OK, that might explain why it’s not so bad, but how could it possibly be good?  If you can take a Pepto and keep your head, this is actually a great time to be investing, be it regular contributions to your 401k and IRA or just regular stock purchases.  If you were excited to buy stocks two weeks ago when the market was frothing, you should be even more so now that stocks are “on sale” at 7% off.

Sure, that might make sense philosophically, but how does that work in real life.  Let’s look at my nephews Risky Fox and Safey Fox.  Risky Fox invests $10 every day no matter what happens.  His twin Safey Fox cut a deal with the investing gods where every day the stock market goes up an equal amount.  Both twins started investing on January 1, 2000, and each has invested $10 every day for those 18 years.  They both start when the S&P 500 was at 1455 at the start of the millennium and they both end last Friday when the market was at 2,620.

Those 18 years have had crazy bull markets and crazy crashes—the dot-com bubble and it’s popping in 2001, the Great Recession of 2008, and the Trump run of 2017.  Those are the big ones but there have been mini-crashes and corrections too like August 2011 and January 2016.

Through all of that Risky invested $10 through thick and thin, no matter where the market was, high or low.  In her bizzaro alternative universe, Safey invested $10 every day , knowing each day the market went up a small but consistent amount (0.0129% each day if you’re curious).

Who ends up ahead?  It would be a pretty stupid column if it was Safey . . . of course it was Risky Fox.  Each invested $45,560 over those 18 years.  Safey ends up with $62,011 which isn’t bad.  But Risky ends up with $89,773, about 45% more.

How does such a thing happen?  In 2001 the dot-com bubble popped and stocks fell 45% over three years.  Throughout all that Risky kept plugging away, investing his $10 each day, but now he was getting stocks at a huge discount.  Stocks recovered after a few years and that looked like a great buying opportunity in hindsight.  Then in 2008 the Great Recession his and stocks fell about 55% in a little over one year.  Again, Stocky keeps investing and when stocks bounce back, he looks like a genius for having kept faith and picking up stocks at a substantial discount the whole time.

And just to prove it isn’t a unique thing, if you did the same Risky/Safey experiment for the 1970s, 1980s, and 1990s, you get similar results.  The 1960s and 1950s have Safey coming out ahead, but by a much smaller amount.

 

Risky

Safey

Difference

2000 to 2018

$89,733

$62,011

45%

1990s

$69,324

$56,044

24%

1980s

$51,181

$48,492

6%

1970s

$28,650

$27,538

4%

1960s

$29,951

$31,100

-4%

1950s

$48,480

$50,926

-5%

 

And never lose sight of the fact that what Safey is doing is impossible.  The market doesn’t work like this.  This just shows that what Risky is doing, something we all “have” to do, really isn’t all that bad.

It’s similar to asking if you can get from point A to point B faster by walking with your feet or flying with your wings.  You can get there with your feet most of the time more quickly, but even if that wasn’t so, none of us have wings.  The whole point is that buying through market down turns (or walking with your feet) does pretty well, even when compared to some fantasy construct.

 

Faith

Ultimately, this is a lesson of faith.  When we were in the depths of the Great Recession, Warren Buffet famously professed his faith in the US economy.  He turned out to be right and made tens billions (billions with a “B”) along the way.

There’s no proof that markets will always go up (predicting the future of human behavior is always impossible), and at the end of the day it’s a matter of faith.  If you believe in capitalism then you believe that stocks will always go up.  I do believe in capitalism so I do believe that stocks will always go up.

That’s what makes the little experiment with Risky and Safey work.  Even when things look horrible, like it did in the dot-com bust and the Great Recession, if you have faith in capitalism you’ll look at the downturn as a temporary turn that will ultimately return to rising prices.  You can see this by looking at a long term stock chart of US stocks: they have an unrelenting upward march through all sorts of markets over 100 years.  Or you can look at the data that shows that historically consistently investing in stocks has never lost money over a 20-year horizon.

S&P 500 since 1950

That brings us full circle.  We’ve been bashed in the face the past 6 trading days.  Stuff like this happens.  I have total faith in capitalism which means I have total faith that things will recover.

When people have asked me what I think will happen/what I think they should do, I tell them to keep on keeping on.  Keep investing in your 401k, keep putting away money in the 529 and your IRA.  It’s probably a lousy time to withdraw a ton of money for a beach house or some other massive expenditure, but beyond that, what’s going on in the stock market really shouldn’t be impacting you at all.

Jan 2018 has been sizzling . . .

. . . and it shows you can’t outsmart the market.

It’s been a mere three weeks into the new year, and stocks are way, way up: US stocks are up over 5%, and international stocks are up nearly 6%.  IN THREE WEEKS!!!  That’s crazy . . . crazy awesome.

As you sit back and count all the money you’re making in the market, let’s put January 2018 into perspective.

 

How special is this?

5% in a month (and we aren’t done yet) is good, but not too special.  Since the S&P 500 began in 1950, there have been 90 months at least as good as this January has been.  That’s about 11% of the time, so a little more than once per year on average.  So that’s not too special . . .

. . . But this one is coming off the heels of some really strong performance.  In the past, most months at had at least a 5% return were rebounding from the previous month which wasn’t that good.  So for example, in September of 2015 that month had a 6.6% return but the month before the market was down.  Same thing in October 2015, October 2011, December 2010, September 2010, and July 2010 (those are the most recent 6 instances).

It might make sense for a really good month if it was sling-shotting off a really bad month, like those most recent examples.  Yet, that’s definitely not what we’ve seen.

January is actually the 10th month in a row that the S&P 500 has been up.  Since 1950 there have been two other streaks like that, in 1954 and 1958 (both of which were 11-month streaks).  So we’re in one of the longest, sustained market runs of all time, and we just busted out a 5.1% month.  That’s a bit like running a marathon and in the 22nd mile kicking out a 4:00 minute-pace.

No matter how you cut this, the market for the past year has been really special.  We’ll be telling our grandchildren about this.

 

You can’t outsmart things

The market is a benevolent teacher.  Actually, maybe not benevolent (some of the market’s lessons can be quite harsh), but certainly a teacher.  There’s a valuable lesson here.

Go back in time three weeks ago.  We were all enjoying football games on New Year’s Day, making resolutions we probably won’t keep, and taking stock (pun intended) of how our investments went in 2017 and what we can expect in 2018.

There was every reason to think 2018 might be a bad year for stocks.  Stocks had just been on an incredible run, so it wasn’t unreasonable to predict a bit of a correction.

Of course, there are a million ways you could go, but there are a ton of really reasonable arguments you could make for why the market might not do so well in 2018.  Yet, so far in January it has busted out a huge month, and if you are fully invested you have made a ton of money.

On the other hand, if you tried to outsmart things and time a market decline, you missed out on a really great month, and that has costed you hundreds or thousands or hundreds of thousands of dollars.

The point of all this is, and I certainly eat my own cooking on this, that you can’t predict the market.  You can spend countless hours trying to figure it out, but it’s unfigured-outable.  The best thing you can do it invest your money and keep it in the market until you need it.

 

That said, I hope you have been fully invested and those numbers on your spreadsheet have been going up and up.