The Wall Street Journal asks an interesting question this week…
As the U.S. stock market continues to set all-time highs, many investors are proudly adhering to their mantra of “buy and hold.” That is what financial advisers preach, and investors are sticking to it.
For now, anyway. The tougher question is this: Will they stick to buy and hold if the market tumbles?
Here’s my guess: Nope.
That’s Mark Hulbert, who knows a thing or two about sentiment and cycles. He concludes that everything we know from prior history tells us that today’s newly converted passive investing diehards won’t last long when the direction of the market shifts downward.
He is right. If you think the $2 billion a week flowing into Vanguard represents some sort of “permanent capital”, a la Warren Buffett’s insurance float, you’re dreaming. If I were at iShares, I’d be strengthening the hinges on all the barn doors in advance of the horses bolting. Because bolt they will, the moment they get spooked.
What’s the catalyst? The first “lower high” for the S&P 500. Meaning the market corrects 10 percent or whatever, then recovers, and then rolls over without having put in a new high. Two corrections with a lower high in between might serve as the signal that what’s been working for years may not work as well anymore. Sure, there’ll be some news story accompanying the lower high – so that reporters have something to point to as the proximate cause of it – but true market professionals know that it’s the price action that determines whether or not something matters. It doesn’t work vice versa. We can only assign these causes afterwards, never in advance.
Investors who have grown accustomed to instant gratification will not react passively to the first instance of their dollars not being treated well. It took awhile for the current psychology to take hold, where everything resolves to the upside regardless of the headlines. We take the escalator up and the gradient is gradual.
It doesn’t take nearly as long for the psychology to fall apart and reverse. We take the elevator down and the cables eventually snap.
This is how it’s always worked.
Many advisors have correctly maintained their clients’ allocations to stocks over the eight years of this recovery period. It was hard to do at first, but then grew easier as both good and bad news has served to strengthen the resolve of the crowd that this is a bull market. I wonder how these advisors are planning to do their job when that resolve is shaken…do they have anything planned for an alternative environment? Do they even remember what it’s like fielding phone calls after a negative quarter? How about a down year? It’s been awhile, since I said I’m sorry…
Our answer to this conundrum is a rules based tactical strategy. We run it entirely for behavioral reasons, which are the best reasons to do anything where household wealth and retirement funds are on the line. Because what awaits the passive investor who cannot truly handle being passive is a trap. Here’s Mark again:
The trap snares them in several ways. Some who now think of themselves as buy-and-hold investors will be quick to throw in the towel at the first sign the market might be entering a correction. These investors then tend to sit on the sidelines too long and don’t reinvest until prices are relatively high again.
Others, perhaps most, wait until it’s clear that a bear market is well under way before giving up on buying and holding and becoming a market timer.
An advisor who isn’t counting on some percentage of their clientele needing more than just emailed assurances probably isn’t being realistic. The good news is, they have the opportunity to plan now, in advance.
What will they say? More importantly, what will they do?