Last year was a high-speed test in managing our emotions

by James Parkyn

In year-end retrospectives over past few weeks, we’ve been reminded just how extraordinary 2020 was on so many fronts.

From the COVID pandemic to the Black Lives Matter movement to the fraught U.S. election and many other momentous events and devastating outcomes, it was a year that challenged our emotional resilience like none other in recent history.

It was no different in the markets. The stock market crash in March gave way to a lightening fast recovery. For investors, 2020 was a real-time, high-speed test of our risk tolerance and how well we’re able to control our emotions in the face of exceptional volatility.

To learn the investment lessons of 2020, it’s instructive to think back to how we all felt at various points during the year. The initial market plunge understandably provoked fear in many, especially because it came at a time of great uncertainty in other areas of our lives, as we navigated a health and economic crisis.

When the markets rallied, many investors were still processing the crash and were distrustful the recovery could be sustained. As it became clear, massive governments and central banks interventions were supporting the economy and markets, investors became increasingly confident in the rally’s durability.

The remarkable market gains since March have once again been concentrated in the technology sector where enthusiasm has been fuelled by the economic effects of the pandemic, including remote work and online shopping. And then there’s Tesla—a phenomenon unto itself.

When fear fades, regret often takes over. How much money could you have made by betting on a few big tech names rather than broadly diversifying your investments?

How about the strength of the U.S. stock market versus developed and emerging markets elsewhere in the world? Wouldn’t it make more sense to concentrate on the U.S. market.

However, if 2020 taught us anything, it’s just how unpredictable the markets can be. Our portfolios must be designed to both weather unexpected developments and take advantage of favourable outcomes.

As investment author Larry Swedroe observed in his review of the book, The Psychology of Money by Morgan Housel, these are not easy psychological waters to navigate.

“Unexpected events and random luck can lead to good decisions having bad outcomes and poor decisions having good outcomes,” Swedroe writes. “Success is a lousy teacher because it can seduce us into thinking we cannot lose. Thus, we should not become overconfident in our judgments when things turn out well. Similarly, failure is a lousy teacher because it can seduce smart people into thinking their decisions were poor, when failure was just the unforgiving reality of risk showing up.”

It’s not easy for bright, successful people to accept their inability to outsmart the markets. However, sticking with a well-engineered portfolio through good times and bad is the hallmark of intelligent investing.

Helping clients manage their emotions is an important part of what we do here at PWL Capital. In that sense, we see our role as advisors helping people make good decisions, not facilitators of risky moves driven by passing emotions.

The coming year will no doubt hold more surprises, but there is much to be hopeful about with the roll-out of vaccines around the world. We will be here to keep your investments and personal finances on track, and the whole PWL team wishes you a happy, healthy and prosperous 2021.

Look beyond the headlines: Patience is the key to building wealth

by James Parkyn

In the spring of 2008, the New York Times published an article with the headline: An Oracle of Oil Predicts $200-a-Barrel Crude.

The oracle in question was Goldman Sachs equity analyst Arjun Murti who was predicting a “super spike” in the price of oil, continuing a run that had brought it to $130 a barrel at the time the article ran in May 2008. (All figures in U.S. dollars.)

“The grim calculus of Mr. Murti’s prediction…is enough to give anyone pause: In an America of $200 oil, gasoline could cost more than $6 a gallon,” the article says.

As the piece noted, Murti was far from alone in forecasting a further surge in oil prices. In Canada, former CIBC World Markets chief economist Jeff Rubin also called for $200 a barrel oil and even wrote a book describing all the implications for the economy.

Sadly for these analysts, the stage had already been set for the collapse of oil prices. The 2008-09 financial crisis and accompanying recession sent prices to below $40 a barrel. But it wasn’t long before prices were climbing again and the oil bulls were back at it, only to be disappointed when the fracking revolution helped flood the world with crude.

It’s been a quite a rollercoaster. Now, think what would have happened to your investment portfolio had you actually taken these headlines seriously and loaded up on the stocks of energy producers and other companies that benefit from high oil prices.

Every day you can find predictions from stock analysts, professional investors and economists about what’s going to happen in the markets.

These forecasts are often persuasively argued, pointing to “fundamentals,” market history and various data points. And they are often wrong.

In fact, the evidence is that the experts are no better at seeing into the future than you and me. Their predictions have been proven wholly unreliable as demonstrated in another Times article. It reports on research into the forecasts made by Wall Street strategists between 2000 and the end of 2019.

“The gap between the median forecast and the market return was 4.31 percentage points, an error of almost 45 percent,” the article says. “The median forecast was that stocks would rise every year for the last 20 years, but they fell in six years. The consensus was wrong about the basic direction of the market 30 percent of the time.”

Actually, market predictions are worse than useless because they generate media commentary that can throw your investment plan off track.

To better understand the danger to your financial health, you only have to think back to the dire headlines at the time the market was falling in February and March in response to the pandemic crisis. For example, a headline in the Globe and Mail on March 12 warned A significant bear market is just starting.

We know in hindsight the market would bottom just 11 days later. On that day, a powerful rally began that saw stocks rise 38% in Canada and 40% in the U.S to the end of June. By the end of August, client portfolios we manage had returned to close to their opening value at the beginning of the year. If the negative headlines had scared you out of the market in March, you would have missed out on that rally.

Of course, we might be headed for another market downturn if there’s a serious second wave of the pandemic or some other negative event in the weeks ahead. And that’s the point—we just don’t know what’s going to happen and neither does anyone else.

However, we do know that $1,000 invested in world equity markets in 1985 would have turned into $28,000 by the end of 2019. That’s why it’s so important to tune out the day-to-day noise and focus on long-term returns.

It may not be exciting, but the only investing news that matters is that patiently holding a broadly diversified portfolio that reflects your tolerance for risk through good times and bad is the best way to build wealth.