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2014: Leverage The Power Of Now In Investing
Staying In The Now Is Key To Investing
Eckhart Tolle's New York Times Best Seller The Power Of Now has sold over 2 million copies worldwide and has been translated into over 30 languages. From an investing perspective, we found the first half of the book to be worth the price of admission; you can draw your own conclusions about the second half of the text. The basic premise of the book is captured in the excerpt below:
"Nothing has happened in the past; it happened in the Now. Nothing will ever happen in the future; it will happen in the Now."
The Twin Thieves: Regret and Fear
Our entire investing lives have taken place in the Now. We have never executed a buy order in the past, nor have we ever executed one in the future. However, we have all wasted a considerable amount of mental energy regretting past investment missteps or worrying about what will happen next in the markets.
Below are a few examples of self-talk we can all relate to concerning investment decisions made in the past:
"The S&P 500 just gained 100 points...how could I have missed a move that big?"
"I am an honest, hard-working, and competent person, why do I continue to perform so poorly in the financial markets?"
"I should have invested years ago, why did I wait?"
"I have missed all the upside."
"Now, I will never be able to retire."
The twin energy-sapping brother to regret is fear about making investment mistakes in the future. Below are examples of self-talk related to fear of future losses:
"It is too late, I can't invest now...the market will peak soon."
"Stocks can't keep going up with the Fed cutting back on QE."
"The economy is getting weaker and stocks will drop."
"Profit margins will narrow, which will hurt stocks."
"A bear market will start the day after I get in."
"The economy is about to slip into a recession."
Past Missteps Are Yesterday's News
Anyone who has invested for any length of time has made mistakes, regardless of their lot in life. The financial markets are a competitive and often cruel place, which means there is no shame in having missteps on your investing resume. Mistakes can be labeled as valuable experience if we are willing to review them in the context of "how can I get better?" However, dwelling on the past in a negative manner will do nothing but reduce your odds of getting back on track.
"Sometimes letting things go is an act of far greater power than defending or hanging on."
No One Can Predict The Future - So Stop Wasting Time And Energy On It
Having worked on Wall Street for 20 years, I can confidently state that no one can consistently predict the future actions of investors and consumers. Since economic and market outcomes are based on the future actions of millions of consumers and investors around the globe, logic tells us no one can consistently predict where the economy and markets are headed. Before some of you get all bent out of shape, the topic of probabilistic forecasting/market profiles will be addressed later in this article, meaning there are logical ways to prepare for the future. As noted in The Most Important Thing For 2014, if the best football handicappers don't perform much better than a coin flipper when trying to predict what will happen when 22 players compete for just 60 minutes, how can we expect someone to accurately forecast the actions of millions of consumers and investors 12 months in advance?
How Can The Now Help Us With Investing?
Would you rather invest based on a forecast with 50-50% odds or would you prefer to invest your hard-earned money based on information known with almost 100% certainty? The future is very uncertain, but we can understand the current profile of the financial markets and economy with nearly 100% certainty. Rather than worrying about what may or may not happen next, investors should focus on the Now.
If we allocate our investment accounts based on today's known information and then adjust as the inputs change, our odds of success will improve significantly.
"If you take emotion - would be, could be, should be - out of it, and look at what is, and quantify it, I think you have a big advantage over most human beings."
John Henry of John W. Henry & Company, Inc.
Is Fear Of A 2014 Recession Holding You Back?
Concerns about future economic weakness are on the fear-inducing and performance-robbing list for investors. Since recessions are declared after they have been in place for some time and the track record of forecasting them is unimpressive to a "not useful" point, it is logical to think in term of probabilities. One of the 2014 Questions was does economic data support an imminent recession? If the answer is no, then worrying about it is not productive from an investment perspective. As covered in detail on January 8, the bond market, based on information in the Now, is not pointing to a recession. If you prefer stats over charts, the following excerpt from Financial Sense fits the bill:
This week the Philly Fed just released its State Leading Index for November which showed that 49 out of the 50 states are expected to see their coincident indexes grow over the next six months. With 98% of states expected to show growth over the next six months, the risk of a coming recession remains remote. Just look at the sea of green on the Philly Fed's State Leading Index map below, where only Alaska is expected to show contracting economic activity over the next six months. Of note, back in December of 2007 when the U.S. economy first slipped into a recession only 32 states were expected to show economic growth in the first half of 2008, as more than one third of the country was already in a recession. Clearly the present backdrop is bullish and does not offer any impending doom to the current economic expansion.
More Hard 2014 Evidence To Combat Economic Fear
Economic data, such as GDP and employment, are examples of observable evidence that can be obtained in the Now. Thursday brought some additional news that aligns with the "risk-on" look of the charts noted earlier this week. From Reuters:
The number of Americans filing new claims for unemployment benefits last week fell and planned layoffs hit a 13-1/2 year low in December, adding to a range of data that have suggested the economy is gaining steam. "The labor market seems to have picked up some steam towards the end of the year," said Guy Berger, an economist at RBS in Stamford, Connecticut. Separately, consulting firm Challenger, Gray & Christmas said planned layoffs at U.S. firms plunged by 32 percent in December to the lowest level since June 2000.
Decisions Made Today Can Eliminate Regret Tomorrow
We cannot go back in time, nor can we change the decisions we made in the past. Therefore, if things have not gone well for you recently, you have to shift your focus to "what can I do right now to avoid feeling this way in the future?" A good first step is to focus more of your brain power on the Now, and less on regret and fear. A logical next step is to determine how you plan to focus on the present.
Was The Economy The Same In 2007 and 2009?
One method to stay in the investing Now involves monitoring and adjusting. Do you believe there were discernible differences between the market's technical profile when stocks peaked in October 2007 and when they bottomed in March 2009? Do you believe the known economic data was discernibly different before and after the financial crisis (October 2007 vs. March 2009)? If the answers are yes, then it is logical to assume there were discernible incremental changes in the hard evidence between October 2007 and March 2009.
Our market model allocates between growth oriented investments, such as stocks, and defensive assets, such as bonds, based on the Now (current market profile). The model makes incremental adjustments as needed based on observable changes in the profile of the economy and financial markets. No forecasting is needed. The two video segments below provide examples of the concepts:
Investing In The Now - How Do I Make It Happen?
A structured system or model is one excellent way to stay in the Now. You should build a model or find a model that passes the "that makes sense to me" test. Any model should be thoroughly backtested. Strict rules are also necessary since a model is useless if you do not follow it 100% of the time (no exceptions). The beauty of the financial markets is there are countless ways to skin the risk-management cat. The articles below cover the concepts of paying attention and adjusting as the evidence changes:
The concept of paying attention is based on probabilistic outcomes, or if you prefer probabilistic forecasting. The difference is we base our allocations on known information, markets and hard data, rather than where we believe the data or markets will be in the future. When the "knowns" change, we adjust our allocations as needed.
1982: Would You Have Predicted An 18-Year Rise In Stocks?
Human bias about the markets is a form of forecasting. If your self-talk is something along these lines, "Stocks cannot go up given all the problems in the world today", then ask yourself how many people felt the same way in 1982?
The events below took place in 1982, or in the first year of an 18-year bull market in stocks:
- A brief but severe recession began in the United States.
- The Hama massacre began in Syria.
- Syrian president Hafez al-Assad ordered the army to purge the city of Harran of the Muslim Brotherhood.
- London-based Laker Airways collapsed, leaving 6,000 stranded passengers and debts of $270 million.
- The DeLorean Motor Company Car Factory in Belfast was put into receivership.
- The United States placed an embargo on Libyan oil imports, alleging Libyan support for terrorist groups.
- The Falklands War began: Argentina invaded and occupied the Falkland Islands.
- Argentina invaded South Georgia.
- A blizzard unprecedented in size for April dumped 1-2 feet of snow on the northeastern United States, closing schools and businesses.
- The nuclear submarine HMS Conqueror sank the Argentine cruiser General Belgrano, killing 323 sailors.
- Spanish priest Juan María Fernández Krohn tried to stab Pope John Paul II with a bayonet during the latter's pilgrimage to the shrine at Fatima.
- Braniff International Airways declared bankruptcy and ceased all flights.
- Hussain Muhammad Ershad seized power in Bangladesh.
- The 1982 Lebanon War began.
- A rally against nuclear weapons drew 750,000 to New York City's Central Park.
- The body of "God's Banker", Roberto Calvi, chairman of Banco Ambrosiano, was found hanging beneath Blackfriars Bridge in London.
- ASLEF train drivers in the United Kingdom went on strike over hours of work.
- Pan Am Flight 759 (Boeing 727) crashed in Kenner, Louisiana, killing all 146 on board and 8 on the ground.
- Checker Motors Corporation ceased production of automobiles.
- The Reverend Sun Myung Moon was sentenced to 18 months in prison and fined $25,000 for tax fraud and conspiracy to obstruct justice.
- The Provisional IRA detonated 2 bombs in central London, killing 8 soldiers, wounding 47 people, and leading to the deaths of 7 horses.
- Torrential rain and mudslides in Nagasaki, Japan destroyed bridges and killed 299.
- In Beaune, France, 53 persons, 46 of them children, died in a highway accident (France's worst).
- Attempted coup against government of Daniel Arap Moi in Kenya.
- Italian Prime Minister Giovanni Spadolini resigned.
- Mexico announced it is unable to pay its large foreign debt, triggering a debt crisis that quickly spread throughout Latin America.
- Italian general Carlo Alberto Dalla Chiesa was killed in a Mafia ambush.
- Iowa paperboy Johnny Gosch was kidnapped.
- Lebanese President-elect Bachir Gemayel was assassinated in Beirut.
- The Lebanese Christian Militia (the Phalange) killed thousands of Palestinians in the Sabra and Shatila refugee camps
- In Israel, 400,000 marchers demanded the resignation of Prime Minister Menachem Begin.
- The 1982 Chicago Tylenol murders occurred when 7 people in the Chicago area died after ingesting capsules laced with potassium cyanide.
- Helmut Kohl replaced Helmut Schmidt as Chancellor of Germany through a constructive vote of no confidence.
- During the UEFA Cup match between FC Spartak Moscow and HFC Haarlem, 66 people were crushed to death.
- A gasoline or petrol tanker exploded in the Salang Tunnel in Afghanistan, killing at least 176 people.
- Camerun president Ahmadou Ahidjo resigned, replaced by Paul Biya.
- Minneapolis Thanksgiving Day fire destroyed an entire city block of downtown Minneapolis, including the headquarters of Northwestern National Bank.
- The first U.S. execution by lethal injection was carried out in Texas.
- The December murders occurred in Suriname.
- An earthquake (Richter Scale 6.0 magnitude) in Dhamar, northern Yemen, killed at least 1,507.
- The United Freedom Front bombed an office of South African Airways in Elmont, NY and an IBM office in Harrison, NY.
- The United States Environmental Protection Agency recommended the evacuation of Times Beach, Missouri due to dangerous levels of dioxin contamination. Source: Wikipedia
Investment Implications - 2014/Now
Last week, our market model detected relatively minor, but noticeable deterioration in the market's risk-reward profile. Consequently, we reduced our exposure to stocks in many client accounts. If the S&P 500 fails to hold at the support levels between 1,820 and 1,830, the model will call for further incremental reductions in equity exposure. For now, we continue to maintain positions in U.S. stocks (VTI), financials (XLF), energy (XLE), small caps (IJR), Europe (FEZ), and global stocks (VT). We will let the market be our guide, given the somewhat vulnerable state of stocks and the economy in the short-run.