AS GOES JANUARY, SO GOES THE YEAR?
There’s an old saying on Wall Street that “as goes January, so goes the year.” In other words, what happens on the financial markets in the first few weeks of the calendar year tends to set the tone for the rest of the year ahead. (It was, apparently, Yale Hirsh of the Stock Trader’s Almanac who first mooted the theory in 1972, but please correct us if we’re wrong).
Well, if the adage turns out to be true in 2022 then we’re in for a rollercoaster ride. But is there really any evidence to back the “as goes January” theory up?
LARRY SWEDROE has been looking at what happened in previous years that started badly for equities. Of course, as regular TEBI readers know, the past does not predict the future. Nevertheless, Larry’s findings may provide some reassurance to those who are anxious about where the markets may be heading.
In investing, convention is to define a market correction as a decline of ten percent or more from its most recent peak. The S&P 500 Index closed 2021 at 4,766. On January 24, 2022, it hit a low of 4,223, a drop of 11.4 percent, qualifying as a correction. A drop that sharp, only the ninth drop of 10 percent for a full month since 1950, causes many investors’ stomachs to roil, often leading to panicked selling. Adding to investor angst might be the old adage that “as goes January, so goes the year”. And if those were not enough to push someone into panicked selling, Jeremy Grantham’s (chief investment strategist of GMO) prediction of an “epic crash” might have been. To help prevent you from abandoning your well-thought-out plan, let’s look at each of these three points.
We will begin with a review of how the S&P 500 Index performed after a month in which it lost at least 10 percent. Since 1950 there were eight other months when that occurred. The worst loss, -21.5 percent, was in October 1987, and the average loss was -13.7 percent. Over the next three, six, and 12 months, the S&P 500 Index provided a total return of 9.5 percent, 16.4 percent and 26.6 percent, respectively. Investors who abandoned their plans due to panicked selling not only missed out on those great returns, but they were then faced with the extremely difficult decision of determining when it was safe to get back in. That’s one of the problems with market timing — you have to be right twice, not once.
To determine the success of market timing efforts of professional investors, we will review the results of the study Static Indexing Beats Tactical Asset Allocation, published in The Journal of Index Investing Spring/Summer 2021. The authors, Joseph McCarthy and Edward Tower, examined how the returns of tactical asset allocation funds (funds that attempt to add value by shifting their allocations) compared with a portfolio of Vanguard’s index ETFs having the same investment style and bond- and foreign-market-augmented same-style Fama-French benchmarks. Their data sample covered the period July 2007-June 2020. As of June 2020, Morningstar listed 85 TAA funds. They found that tactical asset allocation (TAA) mutual funds and fund-of-fund ETFs substantially underperformed static index funds (by 1.77 to 5.15 percentage points per year) that have the same style by far more than the differences in their expense ratios, as well as Fama-French factor benchmarks (by 1.92 to 5.08 percentage points per year) while exhibiting greater volatility.
Vanguard’s tactical asset allocation fund
Using Mr. Peabody’s famous Wayback Machine, we can see how unsuccessful Vanguard was at its attempt at tactical asset allocation. On September 30, 2011, Vanguard announced it was closing one of its worst performing funds, the Vanguard Asset Allocation Fund (VAAPX), firing its advisor, Mellon Capital Management, and transferring the remaining $8.6 billion in assets to another fund, its Balanced Index Fund (VBINX), which follows a passive investment strategy.
Introduced in 1988, the Asset Allocation Fund was free to invest up to 100 percent of its assets in either U.S. stocks, bonds or money market instruments. The fund tactically shifted its asset allocation to take advantage of the “best” opportunities. Unfortunately, the fund underperformed its moderate risk target by almost 3.5 percentage points a year over its last 10 years. And it lagged 96 percent of its peers over the last five years and 79 percent over the last decade while taking more risk.
The failure of VAAPX to achieve its objective highlights just how difficult it is for active managers to generate alpha after the expenses of the effort. Remember, Vanguard is one of the largest money managers in the world, with tremendous resources at its disposal. In choosing the manager to advise the fund, you can be sure it employed its deep team of analysts, and their funds tend to have the lowest expense ratios in their category, yet they failed to find a manager that would generate future alpha. What advantage do you or your financial advisor have over Vanguard that would allow you to believe you are likely to succeed where they failed? Do you have more resources than they do? Are you smarter than they are, or harder working? If you are honest with yourself, the answer is that you don’t have any advantage, nor does your advisor if you have one.
We now turn to the advice from two of the greatest investors of all time on whether you should try to time the market.
Peter Lynch and Warren Buffett weigh in
Peter Lynch, perhaps the greatest fund manager of all time, advised: “Far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in corrections themselves.” Warren Buffett advised in his 1996 letter to Berkshire Hathaway shareholders: “Inactivity strikes us as intelligent behavior.” In his 1988 letter, he stated: “Our favorite holding period is forever.” And in his 1996 letter, he advised: “We continue to make more money when snoring than when active” and added that “our stay-put behavior reflects our view that the stock market serves as a relocation center at which money is moved from the active to the patient.” And finally, he famously advised investors that if they could not avoid the temptation to time the market, at least they should “be fearful when others are greedy and greedy when others are fearful.” It has always seemed to me that the greatest anomaly in all of finance is that, while investors idolize these two legends, so many not only ignore their advice but tend to do the opposite.
We turn now to addressing the question of whether market performance in January determines how it will do the rest of the year.
As goes January, so goes the rest of the year?
To determine if this is wisdom or just another of Wall Street’s myths (like sell in May and go away) or fact-based advice, we go to our trusty videotape and examine returns for each January beginning in 1950 to see if a negative January reliably predicted a negative performance the rest of the year. Over this period there were 28 years in which January produced a negative return for the S&P 500. The average loss for the month in those 28 years was 3.6 percent. However, over those 28 years, the average return over the following 11 months was 5.4 percent. Clearly, it is a myth that as goes January, so goes the rest of the year.
We now turn to considering whether you should act on Jeremy Grantham’s dire forecast.
Acting on the forecasts of market gurus
Before reviewing Grantham’s own record, it’s worth learning what Warren Buffett had to say on the matter of paying attention to such forecasts. In his 2013 shareholder letter, he stated: “Forming macro opinions or listening to the macro or market predictions of others is a waste of time.” And in his book Trade Like Warren Buffett, author James Altucher quoted the Oracle of Omaha advising investors: “We have long felt that the only value of stock forecasters is to make fortune-tellers look good. Even now, Charlie (Munger) and I continue to believe that short-term market forecasts are poison and should be kept locked up in a safe place, away from children and also from grown-ups who behave in the market like children.” Turning specifically to Grantham, we can review his record of similar forecasts of doom and gloom.
In February 2012, with the Shiller CAPE 10 at 21.8, Grantham warned that investors who bought stocks at that time could expect meagre returns over the next seven years. GMO forecasted that after figuring for 2.5 percent in annualized inflation, U.S. large-cap stocks (namely the S&P 500) were poised to return slightly less than 1 percent per year, or under 3.5 percent in nominal terms. How did that turn out? From 2012 through 2018, the S&P 500 Index defied Grantham and returned 12.7 percent per annum, well above its long-term return.
In mid-November 2013, with the CAPE 10 now at an even higher 24.6, Grantham offered the following dire warning: “Combining the current P/E of over 19 for the S&P 500 and a return on sales about 42 percent over the historical average, we would get an estimate that the S&P 500 is approximately 75 percent overvalued.” The firm’s model gave them an estimated real return to the S&P 500 of -1.3 percent per year for the next seven years, after inflation. Over the next seven years, 2014-2020, the S&P 500 returned 12.9 percent, while inflation was just 1.6 percent. Thus, while Grantham forecasted a real return of -1.3 percent, the S&P 500 Index outperformed that forecast by 12 percentage points a year. It’s really hard to be that wrong. And Grantham has continued to forecast epic collapses. Of course, like a broken clock, if you keep repeating the same forecast, eventually you’ll be right. However, investors who acted based on Grantham’s dire warnings missed out on historically very high real returns.
Jason Zweig, columnist for the Wall Street Journal, had this to say about forecasters: “Whenever some analyst seems to know what he’s talking about, remember that pigs will fly before he’ll ever release a full list of his past forecasts, including the bloopers.” And Jonathan Clements, long-time columnist for the Wall Street Journal, offered this sage advice: “What to do when the market goes down? Read the opinions of the investment gurus who are quoted in the WSJ. And, as you read, laugh. We all know that the pundits can’t predict short-term market movements. Yet there they are, desperately trying to sound intelligent when they really haven’t got a clue.” For those interested, this article I wrote in 2015 for Advisor Perspectives explains why I thought Grantham’s forecasts were based on poor assumptions.
We examined each of the three concerns investors might be dealing with and demonstrated that none of them are reasons to abandon a well-thought-out plan, one that anticipates that bear markets are inevitable and unpredictable. In fact, if they didn’t appear in unpredictable fashion, there would be a much smaller equity risk premium (stocks would have produced much lower long-term returns) because stock investing would be much less risky! In other words, investors should consider bear markets a necessary evil to be planned for and not a cause for action other than to rebalance the portfolio and tax-loss harvest, as appropriate.
A fitting conclusion is from legendary investor Charles Ellis, author of the wonderful book Winning the Loser’s Game, who offered this advice: “Market timing is unappealing to long-term investors. As in hunting deer or fishing for rainbow trout, investors have learned the importance of ‘being there’ and using patient persistence so they are there when opportunity knocks.”
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