Key To Weathering Market Moves
This article is part of a regular series on thought leadership from some of the more influential ETF strategists in the money management industry. Today's article is by Michael McClary, chief investment officer of Akron, Ohio-based TOPS ETF Portfolios.
Having written consistently about markets and the economy for nearly 20 years, I have used my share of analogies. They can be an effective way of making the complex seem simple.
Other than maybe sports, due primarily to the fact that I grew up in a house where both parents had coached basketball, I doubt I have used any analogy theme more than the weather.
One of my favorite weather analogies is, “The economy is like the climate, and the stock market is like the weather.” What a great way for investors to understand the difference between two very distinct ideas often used as synonyms.
Is Weather Complicated, Or Simple?
As a long-term investor, focused on providing appropriate results for our investors over multiple market cycles, it is the long-term average weather statistics we are focused on. The daily temperature, rainfall, snowfall, etc., are important as means to an end.
However, it is the end we are most focused on. I estimate we are responsible for the life savings of over 100,000 investors. Those investors reaching their goals is the thing that really matters to us, and them.
Investing, like the weather, is very complicated behind the scenes. I have been studying investing my entire adult life, and I am still learning.
Since it is complicated, instead of focusing on the longer-term weather patterns, the climate or the expected longer-term weather, conversation often reverts to the most recent weather. Investing is no different. My experience is that investors focus on recent weather frequently, if not solely for some.
My New Weather Analogy
Consequently, here is my new weather analogy: In weather, long-term averages can be drastically affected by short-term activity. The same phenomenon exists in investing.
In a given winter in Ohio, it is not uncommon for the majority of the snowfall to occur in a small number of days. In markets, we can see a significant portion of the return over a period decided by a relatively small portion of trading days.
J.P. Morgan runs a study illustrating this concept in its annual Guide to Retirement. They found that missing just the 10 best days in the S&P 500 over the period of 1999-2019 decreased the annualized return from 6.06% to 2.44%, an almost 60% reduction in total return. Underlying those numbers is the similar theme in each underlying stock asset class.
Current Cycle
In conversations over the last few years, I have resorted to simply saying in jest, “Large cap growth stocks have beaten everything forever.” I wrote about this last year, elevating (or condemning) large cap growth stocks to a unique bucket. My other three buckets were other equities, bonds and cash, and hedged investments.
In investing, like in the weather, a significant amount of the average can be impacted by a relatively short amount of time. Also, while abnormal periods can exist, climates tend to change slowly.
In the current cycle, since late September 2020, we have seen the large cap growth “bucket” be outperformed by the other equities bucket by a significant margin.
A Lesson In Investing & The Weather
We have all showed up ill-prepared for the weather at an outdoor event. Maybe it has been hot for a long period and we show up in shorts on a cool and breezy day. Maybe we took that umbrella out of our car a month ago, and all a sudden it is pouring down rain.
Investors should never get too comfortable that the weather is going to stay perfect in the markets. Likewise, those investors who sold all their jackets, umbrellas, boots and ripped the top off their convertible to chase the returns of large cap growth stocks in the late stages of the rally underperformed significantly in the most recent cycle.
The TOPS® Portfolios my team manages are diversified global ETF portfolios, which have provided appropriate risk-based returns to our investors for nearly two decades. Large cap U.S. stocks are our highest stock concentration in every one of our managed portfolios. However, as large cap growth U.S. stocks “beat everything forever” in the most recent market cycle, our diversified portfolios underperformed our best-performing asset class (large cap growth).
For those who think in math, like I do, you will quickly recognize that it is mathematically impossible for a diversified strategic strategy to outperform its best-performing asset class. The challenge is, it’s hard to stay disciplined and patient in investing.
In the most recent rally, I was thankful that our discipline kept us in diversified portfolios, and I didn’t move everything to the large cap growth bucket, assuming the weather was going to stay the same.
Weather—& Market—Predictions
In my lifetime, weather prediction seems to have gotten a lot better. The information and tools meteorologists now have are vast improvements over the “guesses” weather forecasters made for what to expect at my 2nd grade baseball game.
The tools in investing have improved significantly as well. However, investment tools are still very poor at telling us what the weather will be like tomorrow. Until that happens—which, by investment philosophy, it never should—we should rely on other tools focused on optimizing risk versus return.
So, while it may seem like a pain on certain days to carry around that umbrella, over time, we’ll be glad we did.
ValMark Advisers Inc. is the manager of the TOPS Portfolios of ETFs. ValMark started managing "TOPS" separately managed accounts of ETFs in 2002. The firm manages more than $5.1 billion in ETFs for retail and institutional clients in multiple investment products. Email: michael.mcclary@valmarksecurities.com; phone: 800-765-5201. For a complete list of relevant disclosures, please click here.
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