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Confounded by Confluence

Stock prices have been plunging for the last three weeks as coronavirus fears shut down many swaths of the global economy. Conferences and festivals are getting cancelled and surely cruise lines and airlines have no lines. There will be repercussions. Talks of recession may prove true, but that may also be brief. A vacuum of demand has a nasty effect, but might not linger. Imagine the backside of that demand pipeline refilling when this phase passes.

Yesterday was the worst point slide in market history and the largest percentage move in over a decade, kicked off by a confluence of factors, but especially an energy price war between Russia and Saudi Arabia. Many big name oil companies lost half their value in one day. It all looks like a cocktail for disaster. But remember it only looks that way in retrospect. This virus swooped in and upset a seemingly stable applecart. It will likely exit the same way. The market mood gets dominated by greed until fear takes over. It’s the perpetual tennis match.

There are few other things to remember. The history of market moves after a 27% decline are decidedly positive, and often violently so. Professional investors tend to stay invested because they know that tourists spill a lot of cash on the streets while they fumble through their wallet. Flighty individual investors tend to show up too late and leave too late. That’s because they need data to feed their emotional scale which only tips to decision under the weight of evidence, hence always late and backward looking. Statistics show that the majority of pedestrian traders lose money and even those that have a longer-term mindset greatly lag buy and hold strategies. So much so, the most recent Dalbar study of actual mutual fund investor results shows that the actual performance achieved was 3.88% per year over the last twenty years, while the underlying fund investments they owned provided twice that rate of return. This can only be the result of bad timing. Good timing would have exceeded the return and no timing would have matched the return. In the nearly 30-year history of Dalbar producing this annual study, actual investor results have lagged 100% of the time. This happens because we live our lives taking emotional cues, and in most endeavors it’s helpful. Not so with investing. The best thing to do is that which is always hardest. That takes a lifetime of hard knocks to learn, and most never do. In a game of unknowns, faulty decisions repeat. Ask the Bellagio who paid for that fancy hotel with free rooms; those that leave money on the tables, that’s who.

The marketplace creates very few new shares and accordingly, virtually all buy-sell decisions happen within a closed system. Billions of dollars exchange hands daily with buyers and sellers swapping cash for shares and vice versa. The underperformance of the flighty pedestrian latecomer accrues to the benefit of those who hang around. With a closed system it has nowhere else to go. Yes, cash can enter and leave the system. But evidence also says more comes in than goes out, contributing to the coffers of the perennially invested. Tax policy also favors the “loafers” that sit tight because traders generate the worst kind of taxes when they win, and their losses aren’t deductible unless they occur in the same tax year. The Dalbar study referenced above does not include tax drag, which surely makes the 3.88% on the high side of reality.

Because the market has abrupt declines and similar recoveries, the runs get scored by those who sit tight or better yet, those that buy the dips.