By Jack Forehand (@practicalquant)
Last Summer, I published an article where I wrote some letters to my former investing self. Investing is a lifelong learning process and we all make many mistakes along the way. My goal with that article, as I discussed in a recent podcast with Dr. Daniel Crosby, was to look at some of the challenging periods I have experienced in my investing career and to examine some of the lessons I wish I had known when I went through them.
Investing isn’t just about learning from past mistakes, though. It is also about preventing future ones.
Whenever any of us analyze the decisions we make in investing, there is always a tendency to think that what we end up knowing in retrospect was obvious at the time. There is a tendency to believe that decisions that we could have made were easier than they actually were. But that’s just not the way things work, especially when we are faced with high stress situations and very uncertain outcomes, which is the situation we all face today.
Given the vast unknowns we are currently facing with the economy, and the historically high volatility the market is currently experiencing, the range of possible outcomes going forward is extremely wide. Investors have generally settled into one of two camps. The first believes that we are likely in for a major recession or potentially a depression, and stock prices have a lot more to fall. The other thinks this will be a major disruption, but only a temporary
Despite the fact that those two outcomes couldn’t be further apart in terms of what they will mean for investors, they do both have one thing in common: in retrospect, many of us will think the one that becomes reality was obvious at the time.
To give myself something to look back on when I feel this way, I thought it would be valuable to write a letter to the future version of myself in order to paint as clear of a picture of what is actually going on right now as I can.
So here is my letter to my future investing self.
Dear 2022 Jack,
You have now made it through the bear market of 2020. As a result, you now know how it played out. You know whether the predictions of an economic depression that some market pundits made during it ended up coming true, or if we got a much more positive outcome.
But whatever the world you are living in now looks like; whatever the future ended up holding for the stock market; you likely now believe that you knew it would occur.
To dispel this myth, I am writing you this letter to let you know what things actually look like today. I am hoping it will help you understand that what you think is obvious in retrospect was far from it at the time.
So here is where we are as of today.
The stock market is now about 20% off its highs. It is also well off its lows. As I write this on
As of today, cases of the coronavirus are still growing every day, but the exponential growth of the virus seems to be slowing. Investors who are bullish see this as a very good sign and the market is rallying, but there is still no treatment that seems to be working, hospitals in certain areas are still struggling badly, and the country is still mostly shut down. Some experts also think that even if this round of the virus subsides, we will get another round in the Fall, and a vaccine still seems like it is 12-18 months off. So the future of the virus is very unpredictable at this point, especially for someone like you with very limited medical knowledge.
Beyond the medical situation, we all are also trying to figure out what the economic impact is of shutting down the entire economy for an extended period of time. We have never done that before, and anyone who tells you now that they knew how it would play out is fooling themselves. Looking back, you now know how things worked out, but don’t pretend for a second that you knew that when it was happening because you didn’t. At this point, it is very difficult to even figure out how long the economy will shut down, much less what the impact will be.
Another huge influencing force is the U.S. Government and Federal Reserve. The amount of stimulus being provided to individuals and businesses, both large and small, is unprecedented, and the Fed’s balance sheet is expanding by
On top of all of the medical and economic uncertainly, we also have the issue of valuations. The market as a whole was very expensive going into this and as of now, we are only around 20% off the highs. If this ends up being worse than people think from an economic perspective, we certainly have a lot of room to move down before the overall market gets cheap. Small-cap value stocks, which are primarily what you own, are down much more than the market even after struggling for years before this crisis. Your hope that this bear market would play out like 2000, with value stocks holdings up while growth stocks plummeted, hasn’t exactly worked out. Hopefully by the time you are reading this we are in the midst of the biggest small-cap value rally of the century, but that possibility seems pretty far away as of now.
As you can see, there is massive uncertainty right now. To figure out how all of this will play out in the short-term, you would need to be some combination of a stock market expert, an economist, an epidemiologist, and a psychic, and have lots of luck on top of that. You currently do not possess that combination of skills.
Despite all of this uncertainty, you will look back on this situation and you will think that the outcome was obvious. You will think you saw it coming. If the outcome is better than expected, you will focus on the positive information above. If it is worse, you will focus on the negative. But either way, you will think you could have predicted it. And you will be wrong.
Hopefully by writing you this letter I have been able to capture the true uncertainty of this moment. Hopefully the story we end up telling about this time is a positive one. Hopefully the world rallied around a common cause and we found a way to treat this. Hopefully the cases declined over time and there was no additional outbreak in the Fall. Hopefully (but much less importantly) the economy rebounded quickly and the market went on to all-time highs. But either way, keep in mind that as you sit here today, you have absolutely no idea what will happen. And don’t fool yourself into thinking otherwise.
Photo: Copyright: 123rf.com / robertsrob
Jack Forehand is Co-Founder and President at Validea Capital. He is also a partner at Validea.com and co-authored “The Guru Investor: How to Beat the Market Using History’s Best Investment Strategies”. Jack holds the Chartered Financial Analyst designation from the CFA Institute. Follow him on Twitter at @practicalquant.