Each year I set aside some time to reflect on the lessons learned over the past 12 months. I find this exercise to be a prudent use of my time to reflect on missed opportunities, highlight successful practices, and strive to be a better overall investor. I also enjoy looking at past year’s lessons in order to refresh my memory and prepare for a profitable outcome. You can view the 6 Lessons I Learned in 2013 here.
Below are some of the pearls of wisdom that come to mind when I analyze the market, economy, and investor psychology this year.
1. Don’t fight the trend
This is a carryover from last year and continues to be one of the biggest messages the market has sent us throughout the most recent bull market. The trends in stocks, bonds, and commodities have been persistently stubborn despite calls for a reversal.
Logic doesn’t always play a role in market dynamics – sometimes things can be disjointed and stay that way for a very long period of time. You can have a sound game plan laid out from A to Z why stocks should drop, commodities should rally, or bonds should tank. However, fighting the existing price momentum or staying on the sidelines in cash is the surest way to lose money and opportunity.
We don’t always get what we want in the market, but we have to play the hand that we are dealt. With that in mind, keep an objective and balanced perspective that realizes the potential for riding the existing trends even higher. If you are worried about a correction, you can always implement a trailing stop loss or other risk management plan to limit your downside.
2. Volatility is making a comeback
The late stages of 2014 have signaled that volatility is making a comeback. The 10% correction in the SPDR S&P 500 ETF (SPY) from high to low in October along with a subsequent recovery to new all-time highs is just one example. Volatility is also ramping up in the fixed-income markets via the iShares High Yield Corporate Bond Fund (ARCA:HYG) as well.
What does this mean in the bigger picture? The markets are returning to normal cycles of ebbing and flowing capital, 2013 was an outlier year with very little draw down and the gains came easy. Moving forward, expect that reduced central bank intervention in the U.S. will result in quicker moves for stocks and bonds in both directions.
Use volatility to your advantage by having some cash on the sidelines to put to work when markets give you an opportunity.
3. The fear and greed cycle lives on
Everyone talks about the bubble in stocks and bubble in bonds, but the number one thing I see through my analysis of the market is how bearish everyone gets on a 3-5% pullback. That’s not even a blip on the radar on a long-term perspective, but speaks to the quick news cycles, risk aversion, and hot money that feeds on these fear and greed cycles.
I have witnessed the psychological effects of the market in my own practice with great interest this year. During the October correction, several clients called and wanted to sell at the bottom. I mean the exact bottom – to the day. The same thing happened during the sell off in high yield and emerging market bonds during December.
For 2015, lets resolve to have a counter-intuitive mindset. Be greedy when others are fearful and vice versa. It’s hard to do in the moment when you want the instant gratification and safety of cash as the market seems to be falling apart. However, you have to ask yourself whether or not this is the best strategy for your wealth over a longer time frame than the next week or two.
Keeping an eye on the VIX or proxies such as the iPath S&P 500 VIX Short-Term Futures ETN (ARCA:VXX)) can help you identify useful inflection points in this area as well.
4. Inflation is nowhere to be found
Economists, pseudo-experts, and gurus have been warning about inflation for as long as I can remember and it’s still nowhere to be found. Look at the trend of falling interest rates supporting the iShares 20+ Year Treasury Bond ETF (ARCA:TLT)) and PowerShares DB Commodity Tracking Index (ARCA:DBC) continuing to signal abundant supply of raw materials. Core inflationary statistics have been as mild as a Southern California winter for years now.
I don’t know how long that trend will last, but backing up to my first point above – don’t fight the trend. Until we start to see true signs of true inflationary pressures from food, energy, housing, and interest rates you should be positioning in areas continuing to indicate healthy growth. A balanced portfolio of equities and fixed-income with the flexibility to shift into tactical areas showing value may be all you need to overcome this eventual obstacle. Don’t try to get too cute or anxious before there is anything substantive to talk about here.
5. Successful investing starts with a positive mindset
Positivity can take you a long way in your investment portfolio. If you are always searching for the holes in the road, you will never make any real headway. It’s the difference between playing to win and playing not to lose that will separate your investment returns from the pack.
That isn’t to say that you needn’t be mindful of specific risks and have a game plan to deal with bear markets. I am a big proponent of having a risk management plan in place to weather unforeseen events. However, those tools can be used with precision to make prudent changes to your portfolio in order to position it for greater success in the future.
The Bottom Line
2015 should be an interesting year filled with opportunities and challenges that we may not be able to identify right this moment. The key to a successful outcome will depend largely on your investment process and discipline. Be flexible with your asset allocation and open to new ideas as we make our way into the New Year.