FMD Capital Management

The Markets Are Doing That Thing Again

Written by David Fabian, July 18th, 2017

The markets are doing that thing again.  That thing where everything looks easy.  Where the trends are picture perfect.  Where good stocks keep doing good things and bad stocks keep doing bad things.  Where shorting the VIX seems like the easiest money in the world and where commodities are so fractured as to be all but unbearable to own. 

The lines seem so clear and all the prompts so simple to follow.  Every 30 basis intra-day drop in the SPDR S&P 500 ETF (SPY) gets bought.  Fund flows into passively managed stock and bond funds are hitting record numbers.  Life is good.

It’s the type of market that makes you think it’s crazy to be putting new money to work on the long side and suicidal to be setting up shop on the short side.  I always remember the old trading adage that you never short a dull market.  This type of price action is proof positive of that mantra.

Account valuations for any reasonable investor with a structured asset allocation are hitting fresh highs on an almost daily basis.  The high-water marks continue to be moved down the field like first down markers in a high scoring football game.

It’s the type of market that makes conservative investors worry they aren’t doing enough.  Maybe they need to be trading more.  Maybe they don’t have the right stocks or bonds.  Maybe they should be shopping around for a new advisor that is going to take a lot more risk.

It’s this type of market that can be just as dangerous to your psyche as a big crash.  It makes you antsy for change.  It makes you think that activity is going to equate to better returns.  It lures you into a false sense of complacency that makes you quickly forget how easily the good times can unwind and that risk is a two-way street.

If you have followed me for any length of time, you understand that I am a big fan of process.  The hallmark of a successful investor is they stick with an investment strategy they easily understand and can own in any type of market.  It’s not so much about the security selection as it is about making sound behavioral choices.  This is especially true whenever you feel your emotions getting the best of you.

In my own practice, I follow through on that premise by setting minimum and maximum asset allocation guidelines.  I can then gradually adjust my portfolio targets using small tactical changes as needed.  It keeps our portfolios balanced, correlated, and participating regardless of my perceptions of risk.  Even if I think we should be 100% cash or 100% stocks, I know it would be insane to take either extreme given the realistic objectives we are striving to fulfill.

Over the course of my career, I have found that the best compliment to these adjustments is a counter-intuitive mindset.  I want to reduce risk in certain areas when it appears frothy and add risk when everyone is worried about some headline or another.

The Bottom Line

Statistically and logically you may identify with the notion that after the big run the markets have had over the last several years that lower forward portfolio returns are to be expected.  However, it’s hard to square that with the high optimism, low volatility present circumstances that continues to pump out gains.  You understand the risk conceptually, but think it’s not necessarily something to worry about today.

In my opinion, the time to worry is when everything is looking serene.  When it seems like your accounts are firing on all cylinders and you’re getting stock tips from your Uber driver.  Always remember that investing is hard and there will be tough times that follow the good.  Make sure you are psychologically ready for both and make smart choices along the way.

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