What Goes Up, Must Come Down

By Allan Jaster and Jona Husbands, Principals, Archer Consulting Group

With the DOW, the S&P, and many of the other financial indices above their all-time high, the wise investor now turns to discussions of taking some risk off the table.  It’s only logical and prudent to start toning down a portfolio after it’s ripped off four straight years of positive returns (and working toward a fifth year).  We all know that the streak can’t possibly go on much longer.  You’re not alone in your thoughts.  I typed “2013 market crash” into Google and in 0.31 seconds had 281,000,000 results.   If what you just read is resonating with you, chances are you made an A+ in Physics and at this very moment you’re being tempted to lower your G.P.A. with poor scores in Economics and History.

How do you interpret these last few weeks of news and market downturn?   Is it normal investment noise, or do you think that this is a larger signal that the market has finally run out of steam and it’s about to turn south?  As always, we look to history as our objective sounding board.  Below is a table of U.S. stock “streaks” of positive return years.   There are several periods in history where we’ve had some nice consecutive runs.

What_Goes_Up,_Must_Come_Down YEAR RANGE 1947

Interesting, but is this good information to base investment decisions on?  Most people aren’t invested only in U.S. Large Cap stocks.  Instead, let’s get closer to home and look at a diversified 60/40 portfolio and see what sorts of patterns emerge.  Now we only have data back to 1973 (vs. 1926 in the above table.)  But even with the abbreviated time frame the impact of utilizing a well-designed portfolio is positive and compelling… and the streaks are frequent and long.

What_Goes_Up,_Must_Come_Down_YEAR_RANGE_1975

So yes, maybe the streak is about to end… but maybe your diversified portfolio is just warming up for a long run.

To be fair, we’ve skirted the real issue.  The real issue is the high likelihood that the Market, after pushing beyond its previous limits, is about to “return to where it’s supposed to be.”  What are the chances that will happen?  If we apply Newtonian Physics to our problem, we’d say “what goes up must come down” and thus a big Market correction is imminent.   Let’s see if history supports this idea.

Below is another table that captures the historical likelihood of the Market going back down… after it’s broken the previous high-water mark (Of note:  during this 1962-2012 sampling period there were 718 “new daily highs” – S&P 500).

What_Goes_Up,_Must_Come_Down_Look_Ahead

After looking at the above chart (specifically the far right column), you’ll see that breaking through a previous Market high isn’t a negative signal at all.  If you were to apply the principles of Physics you might see this as a negative, but neither History nor Economics support the idea that we’re due for a big regression.   Despite what your instincts might be saying, there’s a really good chance of being even higher than we are right now in a year.   Sooner or later, of course, the Market will pull back.  But breaking through the previous all-time high doesn’t trigger a default forecast of a pending regression.  Also, the risk we run in trying to “time the Market pull-back” is that we’re wrong… and we could be wrong for a decade!   If we did pull back, how would we know when to get back in?   That never-ending cycle of guessing is what frustrated amateurs and many “professional” investors over and over.  Successful investors stay cool while others flap about.

Investing is easy.  Investing well is not.  Our brains are programmed to seek patterns and falsely frame issues in a “Newtonian” way.  We naturally interpret normal market noise as a meaningful signs of things to come.  So it’s logical to arrive at the position that we must be due for a correction and that, “It can’t keep on going up.”   Sure it can.  The Financial Markets skipped school the day gravity was being discussed.

In conclusion, to be a successful investor you must first be an optimist.   Can’t find anything in the Market to be optimistic about?   Look to your left and right.   Just like you, billions of people across the globe are getting up early and going to work to produce because they, just like you, want to provide more for themselves and their families.   That relentless never ending base human desire for more is what you can be optimistic about… and that’s what you’re investing in.

As always, please call with questions or concerns.

Allan Crop        Jona Crop

Allan Jaster and Jona Husbands
Principals

Archer Consulting Group
Financial, Legal and Lifetime Care Strategies
Special Needs Planning
1717 St. James Place, Suite 205
Houston, TX  77056

713.572.1717  Office
713.724.9539  Mobile
713.572.1723  Fax