All That Matters: Weathering a Storm

Weathering a Storm 

Ross: Mike and I are attempting to do the seemingly impossible right now, which is to create content that remains relevant for more than a couple of days amidst the current market storm. We've seen a lot of volatility in both the markets and the real world.

Mike: I recently wrote a piece about when uncertainty reigns (pun intended). It was inspired by the storms we've seen in the Midwest and across the country, as well as the current turmoil in the stock market. In fact, the recent market moves rank among the worst three-day periods in history. This level of volatility is comparable to 2008, 2020, and even the Great Depression. Each of these periods of market downturn had different causes: a financial crisis, a pandemic, a banking panic, and now, the onset of a polarizing trade policy. All of these causes have been unique, but equally tough to navigate. While the past shows us that the stock market tends to grow over long-term periods, getting through these turbulent events as an investor is still challenging.

The Path of a Storm

Ross: 2020 stands out to me as an especially challenging period to be an investor. Similar to what’s happening now, the market dropped quickly and aggressively as the world reoriented itself to an unforeseen challenge. The market must grapple with these events in real time, and it’s borderline impossible to model or predict the path of these storms. Deeply uncertain times are what we plan for, but that doesn’t make experiencing them any easier. But as Mike wrote in his piece, when uncertainty reigns, your reaction to it determines your success or failure. Mike and I have observed the paths of some storms during our careers, and there are a few points worth mentioning.

Mike: Howard Marks, co-chairman of Oaktree Capital Management recently said this, “I want to point out that there are no experts on the subject at hand, the one we're going through, the one you're living through right now. Economists have analytical tools and theories to apply, but no economist, no tool will produce a conclusion in this instance that we can follow with confidence. There have been no large-scale trade wars in the modern era. Thus, the theories are untested. The less obvious truths will be harder to discern.” Many of the world’s leading investors with years of experience leading global firms have never seen the reordering of global trade to the extent that’s happening now –even they don’t have the answers. However, history can help us paint some of the picture. Historically, periods of consecutive negative market performance have been followed by improved one-, three-, and five-year returns, though we know past performance doesn’t guarantee future results.

Ross: When the market goes down that fast, investors are pricing in the worst-case scenario. The reality is usually less extreme than their initial impulse suggests. While investors price in what they think will happen, often the worst-case scenario doesn’t materialize. It's hard to know when storms will happen, but the worst thing you can do, in my opinion, is exit the markets now and miss out on those potential forward returns. As Mike mentioned, the market has only been down 10% or greater over four days a handful of times. The average return going forward is north of 20% and has been positive 100% of the time since World War II. Past performance is not a guarantee of future results, but this is what we’ve seen historically. Now, we don’t know what the one-year, three-year, or five-year outlook will be in a world in which a day’s news cycle feels like a year, and the path forward could very well be volatile. Our partners at Strategas note that after big selloffs, the market may experience a rally; however, more frequently it tends to retest the previous lows. That's when staying invested will feel most dire. We have witnessed short-lived V-shaped bottoms throughout history, but they're not something investors should expect. So, anticipate that the next three, six, nine months could be volatile. The headlines will be noisy, so it’s crucial to keep a longer-term perspective as you digest them.

Mike: No one knows how policy will evolve over time. What we do know is you're not alone in experiencing confusion about what comes next. Typically, when the stock market falls 15% in a calendar year, the overall annual performance is predominantly negative. It has only turned positive for the entire year on three occasions, and two of those (2009 and 2020) followed a crisis. So, there are both favorable and unfavorable statistics. While it’s important to know them, it’s equally important to acknowledge the emotional toll of market volatility.  We hear you – and we know that presenting the historical data may not change your perspective on what’s happening now. Ross and I aren’t here to weigh in on the politics of the situation – everyone has their own views. But even if you strongly disagree with the current policy, that shouldn’t stop you from investing in the long-term growth of the United States. Ross and I both invest through volatility, regardless of our political views on any situation, because we strongly believe that investing in this growth with help us achieve our goals. The market is unique in the sense that one must try to put political views aside.

Ross: Profits can fluctuate; they're not infallible. However, companies’ drive to innovate and generate a profit isn't going away anytime soon. Mike has a great analogy for how companies will adapt to these evolving conditions.

Mike: I heard this analogy from a friend that I believe is quite illustrative. Beavers are adept at constructing dams; they excel at obstructing a river's flow. These industrious creatures can create significant friction in the river, impeding its flow. However, they are incapable of constructing something as monumental as the Hoover Dam. They cannot completely halt the river. Consider tariffs as a form of friction on the economy, global trade, and companies. The river symbolizes U.S. companies—the finest in the world. While tariffs introduce obstacles, they cannot prevent these companies from maximizing their profits. They cannot stop the river from flowing despite the friction. In 2020, companies such as Best Buy, Apple, and local restaurants figured out what to do in the face of a global pandemic. We understand that weathering this storm is difficult. However, will companies adapt in the face of adverse conditions? Yes, they will. Like Ross said, both of us invest in the long-term growth of the United States through its best and worst days.

Ross: We’re recording today on April 10th. Yesterday, April 9th, was one of the 10 best days in stock market history. And that comes on the heels of one of the worst three or four-day drawdowns in the history of the stock market. Just like COVID-19, these days are always tightly bunched. Volatility tends to cluster together. Timing your way in and out of that is, I believe, impossible. To weather the storm, you have to grit your teeth and ride the wave. If you're feeling opportunistic, good investors probably lean into the pain. But the reality is that uncertainty and the way markets act in these times is really painful. Despite all these crises having different catalysts, they all have one thing in common: they've eventually ended, largely due to the profit motive of companies. And that's what we own. That's my big takeaway.

Build Your Umbrella

Mike: If the world were certain, you wouldn't need to build a plan. During a market storm, your investment plan with your Baird Financial Advisor serves as your umbrella. While you may find the current situation distressing, it is essential to stand under your umbrella and weather the storm. We’re living through unprecedented events, so just take it one day at a time with your advisor team.  

Ross: I want to end with the idea of uncertainty. The Policy Uncertainty Index has been referenced frequently lately due to the level of uncertainty stemming from Washington. It’s currently at a level we haven't seen since 2020 and, outside of that, unmatched over the last 40 years. In a recent piece, I flipped it upside down and asked, "When were we the least uncertain? When were we the most certain about things?" The answer from that index was 2007, the eve of the Great Financial Crisis. So, we know uncertainty is coming, but the idea that it goes up and down is a fallacy. Uncertainty is always there. That's why we build the plan, and just like an umbrella in a market storm, your Baird Financial Advisor is here to provide protection and guidance as we look to sunnier days ahead.