4th Quarter 2018: Greenspan Returns

Greenspan Returns

On December 18th, Alan Greenspan, former Chair of the US Federal Reserve, was interviewed by CNN’s Julia Chatterley to discuss his new book, Capitalism in America, coauthored with Adrian Wooldridge. When asked during the interview if he thought we were still in a bull market, Greenspan expressed doubt, saying, “It would be very surprising to see it sort of stabilize here, and then take off again.” He added that markets could possibly go up further—but warned that if the market did go up some more, the following correction would be painful, and suggested, “At the end of that one, run for cover.” These comments came amid the market volatility and declines of December and the interview quickly went viral as news outlets, commentators, viewers and readers quickly seized on them. Newsflash: “Greenspan says investors should run for cover!” Over the four trading days following the interview, the Dow fell a cumulative 1,800 points (almost 8%).

I’m not at all suggesting that Greenspan caused the market to fall. The more likely culprits are higher interest rates, trade disputes, slowing growth in Europe and China and the problems with Brexit. Maybe Greenspan’s comments contributed to price changes, maybe not. I’m suggesting that his comments were fuel for the fire for emotional investors—that any investor with money in the market who saw the speech or more likely, heard or read about it later, had a negative emotional response. A brief increase in heart rate perhaps? A sinking feeling? You had to. How could you not? I sure did. But if you were a producer at CNN or any other media outlet, you loved it! The timing of Greenspan’s remarks was exquisite. Had the interview occurred back in September as the market was hitting new highs, no one would have batted an eye. But coming amid the volatility of December as we watched our portfolios gyrate and lose 1% or 2%, two or three days in a row, comments like these captured 100% of our attention.

We’re emotional sitting ducks. And the media know it. As they say in the newsroom, if it bleeds it leads. The Greenspan bit was only one of many negative stories about the market featured prominently by the media over the last two months as the market swooned. The commentators and “experts” on CNBC, Bloomberg and other outlets create the sense that we should have known this was coming, that we should have sidestepped the decline and especially that we should expect the decline to continue. Starting with the last point, the market may certainly decline further from here. Likewise, it may level off or even go up. But importantly, no one knows. On the other points—the sense that we should have seen the decline coming and gotten out of the market— it is human nature that we feel this way. We think, “Wow, look at all these negative articles…these experts telling me how bad things are and how bad things are going to get. All these folks obviously knew this was coming. Why didn’t I know? What if I had simply moved to cash and waited for the bottom before getting back into the market? Why do I have to go through this? There must be a better way.” Well, you’ve heard it from Bragg before: We strongly believe that there is no better way. And it’s something else Alan Greenspan said that provides evidence that this is true.

Greenspan served as Fed Chair from 1987 through 2006. His term coincided with tremendous economic expansion in the US but also included the bursting of the dot-com bubble (2000-2002) and the subsequent commodities boom and housing bubble that ultimately brought us the financial crisis and great recession of 2008-2009. Greenspan, now 92, is perhaps best remembered for a speech he made in 1996, in which he implied that the market was overvalued and that investors were demonstrating “irrational exuberance” in their appetite for stocks. When he made these comments, he was Chairman of the Federal Reserve. He was, by all accounts, an expert; when he spoke publicly, investors hung on every word and parsed his statements in search of his true thoughts. The Dow was at 6,437 when Greenspan made his “irrational exuberance” speech. His comments made headlines around the world but the market barely hiccupped. Over the next three-and-a-quarter years the Dow climbed another 72% before finally peaking at 11,119 in March of 2000. The market decline that began then took more than two-and-a-half years to finally bottom out in October of 2002. The Dow fell to a low of 7,286 that month, never reaching the level of 6,437 where it was in 1996 at the time of Greenspan’s famous speech.

pWhat if you’d gone to cash in December of 1996? How long would you have waited before giving up and getting back into the market? Would you have gotten back in after 12 months had passed? If so, you would have missed out on the 27% gain of the Dow for that period. Or would you have kept your discipline and held cash through a second year and missed out on an additional 11% gain for the Dow? Is there any chance you would have remained in cash through a third year when the Dow gained 25%, the NASDAQ was up 72% and many of your friends were making a killing day-trading tech stocks? Unless you had sworn off stocks forever, it is a certainty that you would have jumped back in at a higher price at some point, locking in your losses. And having learned your painful lesson, you would have stayed the course (“No more market timing for me!”) and fully participated in the decline that began in March of 2000. You certainly would have fired your investment advisor somewhere along the way had he recommended this course of action. This is just one example of expensive behavior during an emotional time. Market history is chock full of periods of volatility and emotion…go back and pick any year and you’ll find a time when a reasonable investor might have been tempted into a costly portfolio move.

Below we’ve listed a few tenets that are fundamental to our investment philosophy and portfolio construction at Bragg. These help our team at Bragg deal with the market volatility and declines that we are experiencing now and that we will experience again.

• We think stocks will be a better investment over the long term than holding cash or bonds. Even with the volatility of stocks, we think they will outperform over the long term. This is an important assumption. We define “long term” as ten years or more.
• The shares of stock in our portfolio represent ownership positions in real companies. Unlike an ownership position in Bitcoin, which has fallen 80% since its peak 13 months ago, our shares are much more than pieces of paper or digital entries on a computer. We own shares of companies that employ real people who get up and go to work every day. These people get paid to make their companies more efficient, more effective and more profitable. It is important to look past the gyrations of a company’s stock price and remember what it is that we own.
• Today we are being offered a lower price for the shares we own. In the days, weeks and months ahead, if this volatility continues, we may be offered yet-lower prices for the shares we own. We think it makes sense to resist the emotion-driven urge to “sell before the price falls further.” Don’t let the price offered induce you to sell your shares, just as you wouldn’t sell your home to a stranger who makes you a low-ball offer when your home isn’t even on the market.
• Prices are set at the margin and they are set by traders, not by long-term investors. The vast majority of shares owned by individuals and institutional investors rarely trade. When the market declines or becomes alarmingly volatile, avoid thinking “Everyone is selling but me!” They’re not. In general, everyone is holding. Only the price has changed and it has changed as a result of the traders at the margin. Now you and I both know that this point (everyone is holding—only the price has changed) shouldn’t make a rational investor feel better—after all, our portfolio is worth less than before and that stinks. But oddly, whenever we make this point most people seem to feel better. I guess it is a form of herd behavior as in, “I’m with everyone else. I’m okay.” If it makes you feel better, then I guess a little irrational behavior is acceptable.
• Take care of liquidity first. Make sure you can make it through difficult markets without needing to sell shares of stock while they are depressed. For some people, liquidity means an income stream from stable employment. For those in or near retirement, liquidity means having seven to ten years of anticipated portfolio withdrawals (for spending) in bonds/cash. Once liquidity is taken care of, invest the rest of your money in stocks and plan to hold them for many years.

We hope the points made here are useful to you in the days ahead. It is certainly no fun to endure periods of market volatility and it’s no fun to lose money. As a client of Bragg, you experienced both in the fourth quarter. Please know that we take our responsibility to you seriously; we don’t like it when your account is down and we worry when we think you might be worried. We are rebalancing portfolios– trimming bonds/cash and buying stocks (at prices that are lower than prices of three months ago). Please let us know if you would like to discuss your portfolio or your planning. We greatly appreciate your trust in Bragg and wish you the very best in the New Year.