Business Economics Finance Investing

Adjustment Periods are Hard

Most of us don’t like change. We become accustomed to our routines and what we consider to be “normal”. However, periodically throughout our lives we are thrown curve balls which disrupt are perceived sense of normality, whether it be a new boss with a markedly different style than our previous boss, a move to a new neighborhood, a new job or a new addition to your family. We actively choose to make most of these changes but they still can result in a noticeable level of discomfort and require a period of adjustment on our part. Thankfully, humans by nature are highly adaptive to changes in their physical surroundings. We are equipped with a survival instinct that allows us to handle change and continue on with our lives. Resiliency is a key human trait that has been observed throughout history across countries, cultures, religions and genders.

While humans are well equipped to adapt to changes in their physical surroundings, they aren’t really well suited to handling gyrating stock prices and the resultant increases and decreases in their portfolios. Additionally, the human mind can only process so much information which often results in overload and sub-optimal decision making.

Information overload in 2018 is alive and well. It’s really no different from any other year. The media’s sensationalistic headlines and market swings have instilled concern, and even fear, among many. What’s different this is year is that we are in an adjustment period where certain medium- to long-term trends have started to reverse.

After being left for dead in 2017, stock market volatility woke up and startlingly informed everyone it’s back from an extended vacation. While the sharp increase in volatility caught nearly everyone by surprise, it has settled down in the near-term. Not coincidentally, interest rates have been on the rise at a faster pace than we have observed in some time. Historically, stock market volatility noticeably increases when interest rate increases occur at unexpected paces.

Let’s not forget the over-hyped and much anticipated trade war that hasn’t actually started yet. It almost feels like there should be a commercial for the trade war like we see for highly anticipated boxing matches, the Superbowl or NBA Finals. Finally, geopolitical concerns in the Middle East, Europe and Asia have also likely instilled some fear in the investment markets.

The one common denominator of all these headlines is that they are uncertain and unpredictable and because they are uncertain and unpredictable they cause consternation, overthinking and overreaction.

Let’s put some context around a few of these items.

  1. Volatility is a natural investment market phenomenon. It’s always been a part of investing and always will be as long as humans are involved. It should be acknowledged and accepted as such, not feared.
  2. Interest rates do go up, contrary to popular belief. Rising rates reflect a healthy economy and can also reflect rising inflation. Neither rates nor inflation are at levels that are catastrophic. Of course, expectations may be that interest and inflation rates will get to catastrophic levels but let’s not get ahead of ourselves. I’ve read two separate pieces in the past few days discussing the implications of rising rates for stock returns. The first piece concluded, based on historical evidence, stocks move higher with rising rates and inflation, especially when moving from low rates in a low inflation environment. The other piece examined subsequent stock returns when the 10-year UST yield was higher than one year prior. Stocks were up one year later 74% of the time with a median return of 10.4%. Barring some other unexpected shock to the system, it would appear we shouldn’t be fretting too much about stock returns in the context of rising rates over the next 6-12 months.
  3. The impending trade war appears to be less and less likely with each passing day. Something of this nature is obviously highly unpredictable but it appears the U.S. continues to walk back its threats. It’s good to be informed and understand the implications of a prospective trade war but by no means should you be making investment decisions based on something that isn’t going to happen for certain.
  4. Geopolitical concerns are ever present and out of our control. Most conflicts have no meaningful impact on the fundamental drivers of stocks. These issues generally only have a transitory impact on stock prices so we should strive to avoid overreacting to headlines and fear-mongering.

In the end, there are only so many things we have control over. The most important thing we control is our behavior. It has been said that investment behavior, not investment portfolios, is the biggest driver of success in achieving long-term financial goals. Regardless, adjustment periods sure are hard.