FMD Capital Management

This Will End Badly

Written by David Fabian, July 14th, 2016

There is a phrase that is often associated with euphoria, bubbles, and overheated markets.  Four little words that proclaim: this will end badly.

I have even felt myself utter that phrase during various stages of my investment career.  Sometimes it’s true and other times it’s not.  It’s most prevalent when you see a specific asset class behaving in a way that many people think it shouldn’t.  Bonds that act like stocks.  Stocks that act like bonds.  Trends or correlations that seem like they will never end.

These are some of the most common examples, but it doesn’t stop there.  Some people think the whole system is rigged.  They think the Fed is manipulating the markets.  They believe that robots and algorithms have taken over control.  They are even skeptical of investment vehicles like exchange-traded funds because they are prone to temporary trading hiccups that are demonized in the media.

So the only logical choice is to stay on the sidelines.  Hide out in cash and wait for the apocalypse that will come with global upheaval, hyperinflation, currency devaluations, social unrest, and general chaos.  It will end badly they assure us.  This time it’s different.

The Evidence

Yet despite all those assurances of destruction, something interesting happened this week.  Major stock and bond indexes hit new all-time highs.  Not only that, many commodity funds have also experienced some of their biggest gains in years.  That doesn’t sound like the makings of a broken system to me.

Even just a simple 50/50 portfolio of the SPDR S&P 500 ETF (SPY) and iShares Core U.S. Aggregate Bond ETF (AGG) is up about 6% this year.  That’s not too bad for six months’ work.

Investors who have stayed true to a disciplined, diversified, and sensible investment approach are probably seeing their accounts at or very close to the largest balances ever.

The tin foil hat crowd?  Not so much

The Subterfuge

It’s a funky world out there.  Negative interest rates are the new normal.  Stock market valuations are near the top end of their range (with the exception of the early-2000 bubble years).  Precious metals have been a disaster for a half decade and are now just starting to perk up again.

Some people are screaming that this is just the start of the biggest bull market in the history of the world.  Others are proclaiming that the truly darkest days are not far in the future.

I can see where the skepticism comes from.  Who do you trust at times like these?

It’s easy to let fear drive your investment decisions.  It’s a powerful motivator and you can easily rationalize a lack of exposure in stocks or bonds to protecting your best interests.  Nothing could be further from the truth.

The Reality

The truth is that listening to the advice of fear-mongers has been an absolute disaster for your portfolio returns.  They are right every now and then, just like a broken clock is right.  There are bear markets and recessions that come with enigmatic frequency and leave just as suddenly.  There is no perfect way to predict those entries and exits.

Ultimately, this current period of strength will fade and we will be forced to endure another setback in the markets.  That’s OK though.  It’s how you prepare and react through those cycles that is most important.

That starts with having a strategy.  “This will end badly” is not a strategy.  It’s an opinion.

Furthermore, if you haven’t had the fortitude to invest when things are relatively calm and showing meaningful trends, what makes you think you are going to hit the nail on the head if this thing does collapse?  It always looks 100x worse on the way down and especially right before the markets turn higher again.  That’s the nature of the game and why investing can be so frustrating.

The Plan

I’m not wildly bullish about stocks or bonds at this moment in time.  However, I still adhere to a fundamentally sound game plan of holding core positions in both asset classes.  That way my opinions don’t get in the way of compounding my client’s wealth.

Having a little cash on the sidelines can be a good strategy.  It can allow you the flexibility to add fresh themes or wait for a pullback so that you can put that money to work.  Being 100% cash for the last 1-3 years isn’t a strategy.  It’s a good way of ensuring you won’t hit your goals for buying a home, retiring, or generating sustainable income from your nest egg.

If you have been on the sidelines and are unsure about how to step out of the shadows, try some of these simple steps:

  • Identify areas of the market that you want to get exposure to. Make sure to include a diverse array of asset classes to mitigate risk.  My favorite way of accessing the market is through ETFs because of their built-in diversification, low costs, and complete transparency.
  • Break up your planned allocations into multiple parts. You don’t have to go “all-in” on day one.  Consider putting small pieces to work over multiple weeks or months so that you can use time and price to your advantage.
  • Avoid trying to make up for lost time by treading into overheated areas of the market or opting to start a second career day-trading. Becoming overly aggressive near the highs may set you back even further and erode your confidence as well.

There is no easy or guaranteed road to success from here.  However, there are time-tested principles that will serve you well with enough patience and foresight to let them work.  The first step is realizing what you have been doing may not be in your best interests and taking a proactive approach to changing that thought process.

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