"Finally, while my observations are uncertain and should be taken with a grain of salt, what I am sure of is that valuations and markets are elevated, and the easy money in this cycle has been made." - Howard Marks, Oaktree Capital Memo (July 2017)
"The easy money has been made."
If that saying sounds familiar, it's because you've been hearing it over and over again since 2009…
In hindsight, the path higher since March 9, 2009 indeed seems like "easy money." The S&P 500 has returned over 340% including dividends - more than quadrupling - with 160 all-time highs along the way.
What could be hard about that?
To answer that question, let's take a look back over the past 9 years…
Try to remember the psyche of the average investor in March 2009. Faced with the worst bear market (-57.7% from the peak in October 2007) since the Great Depression, they were being told why prices could go lower still.
Here are a few of the headlines around the bottom…
Needless to say, it was not "easy" to buy at the time, especially after what investors had just experienced.
The case for further declines seemed airtight: earnings "drive" stock prices, and earnings were going down, not up. Not only were they going down - they were negative - the worst in history.
How could one buy or hold stocks amidst such weakness in earnings?
There's only one way: if they did their buying/selling based on evidence over opinion.
You see, as it turns out, stock prices lead earnings, not the other way around. Going back to 1871, if one had sold stocks every time earnings were lower (year over year) and only bought back in only when earnings were higher, they would have lagged a buy-and-hold investor by 3.7% per year. Trading earnings through the rear view mirror is not an effective investment strategy.
Why is this the case? By the time earnings data is released on the prior quarter, the market is already looking ahead to the future. When the future stops looking like the prior quarter, problems arise when using earnings to time your exposure to stocks.
That's precisely what happened in March 2009, after which the future stopped looking like the recent past. By the time earnings turned back up in 2010, the S&P 500 had already surged substantially higher.
If you held your position throughout 2009, there would be a new set of challenges in 2010.
The most difficult of these occurred on May 6, 2010. In what will forever be known as the "Flash Crash," panic selling and a waterfall decline ensued.
While the market would recover more than half of its losses by the end of trading, it was still the worst single-day decline for the S&P 500 since April 2009. It was also a so-called "90% downside day," meaning that down volume accounted for over 90% of the total volume on the NYSE. Pundits came out in force saying that the severity of the decline was a bearish omen, as they do on all such days.
How could one have avoided falling prey to such prognostications? By basing their investing decisions on evidence instead of opinion.
Looking at the data going back to 1970, the average returns following 90%+ downside days are not only positive but higher than your typical day.
Instead of fearing panic, the more rational response from investors would be to embrace it.
If you held your position throughout 2009 and 2010, the biggest test of all would come in 2011.
The S&P 500 would decline roughly 20% from its peak May through the low in October.
The thinking at the time? Such a large decline could only mean one thing: another recession was coming. And if another recession was coming, that would mean more declines for stocks.
"The stock market is a leading indicator of the economy," they screamed. "Surely something must be very wrong with the economy for stocks to be down as much as they are."
The only problem with such logic: the stock market is not the economy. While the stock market often starts going down in advance of a recession that does not mean that every time the stock market goes down there is going to be a recession. Far from it.
Before 2011, we had seen 8 bear markets (20% declines in the S&P 500) without an accompanying recession since 1933. After 2011, this number would move up to 9.
If you held your position from 2009-2011, you were probably feeling pretty good in 2012 when the S&P 500 (total return) hit a new all-time high.
That feeling would not last very long, as pundits started saying that the new highs were pointing to a top. What evidence did they present supporting such a position?
If we look at the actual data going back to 1928, we find that all-time highs are not indicative of anything other than a market that has been going up.
What tends to follow new all-time highs? More all-time highs.
From the first all-time high in 2012, the S&P 500 has gained an additional 98%.
If all-time highs in 2012 didn't scare you out of your position, "rising rates" in 2013 were said to be the "death knell" of the bull market. The pundit's logic: if low rates were the "reason" for the incredible run-up from 2009-2012, then surely higher rates would have the opposite effect.
Confounding the experts, the S&P 500 would advance 32% in 2013, its best year since 1997.
But what about those "rising rates?" As it turns out, there is a 0 correlation between the S&P 500 and 10-Year Treasury Yields, meaning one cannot say anything about equity market performance based on the direction of interest rates.
Since 1928, stocks have actually fared better in years where interest rates were rising than falling.
If you held your position through "rising rates," the biggest threat yet was said to come from King Dollar. In the back half of 2014, the U.S. Dollar Index experienced an unrelenting advance as markets began anticipating an end to Quantitative Easing.
Since a falling dollar and easy Fed were said to be responsible for the gains since 2009, the opposite environment was said to unwind all such gains.
The only problem with this line of thinking? It wasn't supported by the evidence. The S&P 500 and the U.S. Dollar Index have a 0 correlation historically, meaning that even if you knew where the Dollar was going, it wouldn't tell you anything about where the stock market was going.
It should come as no surprise, then, that the S&P 500 would end 2014 up 13.7%. When it comes to the stock market, there are better things to worry about than King Dollar.
If you held through the Dollar's epic advance, then the sharp decline in Crude Oil was the next issue to confront in 2015. The crash in Crude was said to be evidence of a weakening global economy, and a wave of resulting bankruptcies in the energy sector was predicted to wreak havoc on global credit markets.
It all sounded quite ominous at the time, but does the S&P really need higher Oil?
The answer based on history is a resounding "no." The monthly correlation between the S&P 500 and Crude Oil is essentially 0, and the S&P 500 had experienced gains many times in the past amidst a decline in Crude Oil. It would do so once again this time around.
As the Fed hiked rates in December 2015 for the first time since 2006, it was the opinion of many that one should sell all of their stocks, particularly in Emerging Markets. Needless to say, such calls were based on nothing more than conjecture, as the evidence with respect to prior rate hikes (even the most extreme hikes) pointed to further gains, not losses.
Not only did Emerging Market stocks not suffer from the hikes as predicted, they would go on to outperform.
If you held through the end of 2015, your willpower would soon be tested yet again.
In early 2016, the S&P 500 experienced a sharp sell-off (the worst start to a year in history, in fact), hitting new 52-week lows in January and February. Such an occurrence was said to be extremely "bearish," and evidence that the market was going much lower.
What did the data suggest? Quite the opposite. Average returns following new 52-week lows were actually positive and above average in most instances.
Near the market's lows in February, another concern emerged: politics. The rise of Trump and Sanders was said to be "correlated closely with the decline in stocks."
Many pundits suggested that "political risk" was high, and investors would do well to sit out the year and wait for the "uncertainty" to abate.
How would such a strategy fared historically? Not very good. As election years have historically returned slightly higher than non-election years (9.6% vs. 9.5%), sitting them out would have resulted in a return 2.5% below a simple buy-and-hold.
The S&P 500 would end 2016 up 12%, once again showing that mixing politics with your portfolio is rarely a good idea.
Neither is basing your investing decisions on volume. The volume spikes and subsequent declines during and after market corrections were said to be bearish omens each and every time from the March 2009 low.
What did the data say: that such a notion was a big lie. Stocks did just fine, posting strong returns going forward. As it turns out, volume spiking during a decline (when there is more uncertainty and volatility) is perfectly normal, as is the decline in volume during a subsequent advance (when uncertainty/volatility is lower).
If you held throughout 2016, an outside observer might consider 2017 a breeze. This has been the least volatile start to a year since 1964 and there hasn't been as much as a 3% correction the entire year.
What could possibly be hard about that? Everything. The fear of lack of volatility can be almost as strong as the opposite. The constant barrage from pundits saying things like "the calm before the storm" and "this won't end well" started in early January, when market volatility was lower than 97% of historical readings.
What evidence is there that low volatility means stocks cannot continue higher? None (stocks still tend to rise on average from very low volatility readings), but that did not stop the many calls saying as much.
In February, when the Nasdaq 100 Index hit one of its most overbought levels in history, the "top" calls were out in force, comparing it to overbought levels in 1987, 1998, 2000 and 2007.
What evidence was there saying an overbought market couldn't continue higher? None, as you'll note in the table below the positive subsequent returns on average.
That's indeed what we saw in the following months, as the markets continued higher and the Volatility Index (VIX) hit new all-time lows. As it turns out, overbought conditions can be bullish and low volatility conditions aren't necessarily bearish.
If all of this sounds confusing, good. It should be. No one said this game was easy. Wait, that's not true - many are saying just that. The gains from 2009 through today are all deemed to be "easy money" in hindsight.
But those who lived through it know otherwise. The 21 corrections since March 2009 all seemed like the end of the world at the time. Each and every one was difficult to hold through.
Noise: Can You Ignore It?
The only way you had any chance of holding your position was to tune out the noise (extreme forecasts, predictions, calls, prophesies, targets and myths), have a plan, and stick with that plan when you were punched in the face. Nobody likes getting punched in the face but as investors you will have to take that punch and more if you are going to succeed.
Why is ignoring noise so important? Because it's not thinking that makes the big money in markets but sitting (a la reminiscences of a stock operator). Sitting through big market advances and allowing your investments to compound is hard enough, but it's infinitely harder to do when you're being compelled to take action based on falsehoods.
Ego: Can You Surrender It?
In the compelling Netflix documentary "I Am Not Your Guru," Tony Robbins tries to help people from all walks of life get over their fears. It has been my mission here to do something similar for investors, to try to help you surrender your ego and get over your fear of saying three important words: I don't know.
Why is knowing something, or more accurately thinking you know something, so detrimental? Because knowing leads to overconfidence, which in turn leads to overtrading, which in turn leads to underperformance.
Knowing (or thinking you knew) why the S&P 500 suffered those 21 corrections was more harmful than helpful, as it likely justified (in your mind) an action that was based on emotion instead of evidence. Is there ever a reason to sell something? Sure, but it should be based on evidence and executed in an emotionless, systematic fashion. And it should be done with humility, understanding that it could very well be wrong. In fact, as there is no holy grail in investing, one should expect it to be wrong quite often.
Will the markets become harder to navigate in the years to come? I don't know, but it seems like a reasonable assumption to make given the record-low volatility and unusually low drawdowns we have experienced of late. But getting harder tomorrow doesn't imply that it's easy today. There's no such thing as easy in investing.