Preventing Emotion From Causing Bear Market Mistakes

July 14, 2022 at 8:30 A.M. E.T.

Transcript:

Daniel Dusina 00:08

All right, everyone. Well we are at half past eight, so I think we should get started here. Just as a quick heads up, this webinar is being recorded. So, if any of you ever end up not being able to make any of these monthly webinars that we'll be putting on, you can always check out the Blue Chip Partners blog for some of these webinar replays, as well as other great information from the team. So be sure to follow us on LinkedIn, as well as be a frequent guest of our blog for all the most up to date information. Well, first and foremost, thank you all very much for joining the second live webinar that we're putting on here at Blue Chip Partners. I think this is a very topical, timely, and very interesting one for you all. Today, we're going to be talking about why it's challenging to be a good investor. And so, certainly we could take this in a number of different directions, but some of the headline thoughts that we have. And I guess, just as a heads up, I'm joined by Dan Seder and Matt Mondoux here at Blue Chip Partners. But today we want to talk about, number one, why it's important to not become a pawn of the financial media. Dan will talk about the motivations of us as investment professionals relative to the motivations of those in the financial media before we turn it over to Matt Mondoux, who talks a bit about sentiment in the market, and what historical data will tell us about sentiment in the equity markets today. Finally, I'll be wrapping up discussing a little bit about valuations, what exactly that means because I'm sure some of you have heard that term tossed around, as well as some historical context and where we find ourselves today. So, with that, I will turn it over to Dan to talk a bit about the financial media and their motivations.

Dan Seder 01:54

All right, Daniel, thank you for that intro. Our goal is to keep this webinar short and sweet. So, I plan to keep my part under five minutes. And as Daniel mentioned, if you haven't already done so, please follow us on LinkedIn: Blue Chip Partners, myself, Daniel, Matt Mondoux. Excited to talk today about three items that can help you avoid becoming a pawn of the financial media. And I must admit, it's one of my favorite subjects.

First, I'll talk about what motivates the financial media. Secondly, why fear sells. And third, how awareness is key. So, let's jump into it. With the rocky start to the markets this year, it can be easy to get emotional about your portfolio. But along the way, it's important to understand the psychology and vested interests behind what you're reading, watching, and hearing. Beware the financial media and investment professionals like us have entirely different motivations. For Investment Advisors. Our main goal is to help our clients execute a successful financial plan that often includes growing their portfolio. We strive to sell investments at a higher price than we bought them at. The media, on the other hand, isn't equipped to give you financial advice. And if you think about it, how could they? Investing is so personal. The media knows absolutely nothing about your specific circumstances, they don't know your family, they don't know your risk tolerance, they don't know your timeframe or your income needs in retirement. The fact is, the goal of the media isn't to give you financial advice. It's to sell advertising. And the more they get your coming back, the more advertising they sell. And it's just that simple. And believe me, they know what sells is fear. So, if you think about what's on CNBC, it's always breaking news, the Dow down “this,” the recession “that,” Russia, Ukraine, Biden, inflation. The list goes on and on. Even the background music that they play is often a little creepy. You never see a headline that comes across that says, “Things are going to be just fine. Check back with us next year.”

So, here's the science behind it all. There's a section of our brain called the amygdala as part of our human evolution. The amygdala acts as our danger detector, that quickly works through all the information in front of us and identifies anything that can put us in danger. And, if you go way, way back, it's how our ancestors avoided being preyed on by dangerous animals. So, I guess in today's day and age, we don't have to worry about being eaten by a lion. But that danger detector still plays a huge part in our daily lives, particularly how we deal with money and the potential loss of it. The media moguls know this vulnerability extraordinarily well and creatively exploit it with the bias of their message towards negativity. So, at the end of the day, what should we all do? Should we turn off the TV? Should we turn off the radio show? Stop reading the Wall Street Journal, maybe, but at the very least, simply reminding yourself what motivates the media can help you make better decisions with your head instead of your heart. So, here's an example: beware when magazine covers get extreme, the message could be dead wrong. In fact, there's something out there called the Magazine Cover indicator, which is often used as a contrarian signal. A few of the many examples, and I just have three listed here today, include Business Week’s, “the death of equities” in 1979. On the brink of a multi-decade run in stocks, here’s The Economist cover titled, “The New Tech Bubble” in 2011. And we all know what tech did over the last decade. And finally, The New Yorker, just a week after the COVID lows in 2020. So, here's some eye-opening stats. This particular slide is from Charlie Bilello on CNBC’s ”Markets in Turmoil.” So, “Markets in Turmoil” are special reports that effectively revolve around the doom and gloom, and the media reporting on the doom and gloom. This table, the numbers might be a little small, highlights the dates when the special reports were aired, and then shows forward-looking returns in the stock market. So, really interestingly, the average one-year forward return on stocks was 40% and the average total returns since each airing was 100%. So when you look at the numbers here, I guess we could argue that CNBC finally has an indicator with a perfect track record. So the bottom line is this, yes, the financial media can be entertaining, but take the message with a grain of salt and don't consider it a source for financial advice. Those who achieved the best outcomes don't get distracted; they have a plan and they stay disciplined. And with that, I'll pass the mic over to Matt Mondoux. Thank you for listening; and again, just a reminder, please follow us on LinkedIn.

Matthew Mondoux 07:09

All right, thanks. Thanks, Dan, I appreciate it. That's some really good information, and I'm excited to share how a lot of what Dan just talked about flows through to the actual Senate, within the markets, and how individual investors feel. Oh, you know, there's a lot of reasons why they may feel this way. We do feel the media is one way, and often the market is the other. So this is a pretty scary-looking chart. Hopefully nobody's amygdala is going off right now at 8:30 in the morning.

I'll explain what you're looking at here. There's two lines that I want to focus on, and I'm going to emphasize one; the blue line is the bullish reading by the American Association of Individual Investors. They capture individual investor sentiment on a weekly basis, and they've been doing so since 1987. This makes this one of the longest, if not the longest-standing, surveys of individual investors that we have, really amongst any financial database. So it makes it very significant. So again, every week, they survey their membership base and ask people if they would be bullish, bearish, or neutral. Most of the time, you can see that the chart kind of bounces around in the middle, both on a bearish, which is the orange, the faded orange line, and a bullish reading, which is the dark blue. So, we often say 90-95% of the time, this data point really doesn't tell us a whole lot other than people are mostly fine. Some people are worried, some people are bullish. But we're kind of in the middle, where the sentiment indicators work really well from a market return standpoint, or some type of indicator is at extremes. And what you can see here, this goes back 30 years all the way to 1990. In focusing again on the blue, the dark blue line represents the amount of individual investors who identified with being bullish over the next six months. We were actually at a level we had not seen since 1990. So, when this survey was in its infancy and even lower levels amazingly, surprisingly to me and the rest of the committee, lower levels than we saw in March of ‘09. So, we have more or less bulls now than we did in March of ’09, which was another extreme. Well, that tends to be a pretty good indicator of stronger market returns going forward. Daniel, please switch to my next slide here. I intended to make this one a little more fun. This is the same data zoomed in a little bit. Again, this just helps identify the current time period. We have a shark's mouth here; I'll get to that. But you can see low bearish or high bearish readings, low bullish meat readings. And these readings never remain apart for too long. We often say the shark's mouth will close. And that's something that we would expect people will not remain bullish forever and they won't remain bearish forever. And Daniel, if you could go to my final slide here.

The last time we had such a wide gap between bears and bulls was during the market lows of ‘09. This data suggests that the preceding 12 months follows not only bearish extremes, and low bull ratings produce really strong market returns. So, when bears outnumber bulls by more than 35 points, the market returns over the next 12 months have been positive 12 out of 13 instances since 1990, with the average return just shy of 20%. And confirming that when less than 20% of individuals are bullish, market returns are positive in 1920 instances, with the average return being about 17.5%.

So, at the end of the day, why does a bear market end? When we run out of sellers, and that's the same reason a bull market ends. A bull market will end because we've run out of buyers. This really highlights the emphasis of, you know, being a contrarian, particularly at extremes. That's when it can make the most sense. That's when you get the Warren Buffett ideology of “buy when there's blood in the streets.” It's really when you're at an extreme in some level of sentiment that that kind of strategy will make the most sense. And again, this is a reason to not be overly bearish in these markets. Recognizing everybody's bearish, you often want to zig when everybody else is zagging within markets. And this is just another, maybe, some reason to be slightly more positive than, as Dan pointed out, the financial media would lead you to indicate.

Daniel Dusina 12:34

You know, I think that what I'm about to cover gels incredibly well with what Dan discussed, with regards to the fear stoked by the financial media, as well as the investor sentiment that we have seen in the past and are currently seeing today. And the first thing I will say is that one thing that we lose sight of when the market is down, is that the equity markets are the one place that when things go on sale, everyone heads for the exits. And so, what I'm going to walk through will be exactly what we look at in terms of determining when things are on sale. So, referring to valuation, this is a term that many of you will have probably heard us cite in our outlook pieces, commentary, or in general discussions. But what valuation refers to is how expensive or how cheap security is in the market. And so, while there are a number of different valuation metrics to determine the cheapness or the expensiveness of a security, the most common valuation metric is called the price-to-earnings ratio. The price-to-earnings ratio, as its name would imply, simply takes the price of a stock divided by the company's earnings per share. And so, a higher price-to-earnings ratio will be determined as more expensive, while a lower price-to-earnings ratio will be termed a little bit cheaper. And so you can think of this price to earnings ratio logically as what an investor is willing to pay for a participation in a company's earnings. Certainly this can move around either given movement in a stock's price or moving into the denominator, which is earnings per share. I think it's beneficial to walk through two different scenarios to help explain and dictate kind of where we are today. First and foremost, in this scenario, looking at the chart on the left, with a company's price per share in brown and their earnings per share in blue, we can see that when a company's stock price is increasing, and the earnings are also increasing over that period. The chart on the right shows the price to earnings ratio of that company. So, you can see over that period of increasing stock price and increasing earnings, the price-to-earnings ratio expands for this specifically. It would be evident that the stock price is advancing more than the earnings per share, so that valuation becomes more expensive. In a secondary scenario, we can see the same charts. With the stock's price in the left chart in brown and the earnings-per-share in blue, with a declining stock price but resilient and growing earnings, the price to earnings ratio compresses and the stock's valuation becomes more attractive. Certainly, we could have a similar situation, if the stock price stayed stagnant and earnings increased, we could have the opposite scenario, if a stock's price remained stagnant and earnings decreased.

The point is valuations can move around over time. But determining a company's valuation is important to see relativity. So looking at a company's valuation relative to its own history, or relative to a sector or relative to an index, we also can look at broad market valuations, which can be incredibly important,\ and also very helpful in determining where we might find a bottom, as Dan mentioned. Matt has indicated sentiment is at very low levels; certainly everyone is a bit nervous given the activity and the volatility that we've seen year to date. But the fact of the matter is, this year for the S&P 500, we have had fairly resilient earnings growth. Right now we're targeted at an estimated 7% earnings growth for this year. So, although stocks are off south of 20%, earnings have remained robust. And so what that gets, as we've walked through in the previous two slides, is that the attractiveness from a valuation perspective is certainly there. Looking at the 30-year average, we've recently dipped below for the S&P 500 on a price-to-earnings basis. And while this isn't necessarily indicative of an immediate bottom, it certainly bears consideration that we are finding ourselves with securities on sale. So we at Blue Chip Partners, we're not heading for the exits, we're trying to find attractive opportunities that are on sale, which haven't been for a number of years, looking at where we might find a bottom in stock prices. If you'll take a look after the meeting at our Quarterly Edge on the Blue Chip Partners blog, I put forth some interesting information from a price perspective. We can also look at this from a price-to-earnings perspective if you look back to 2020 for the fourth quarter of 2018. The S&P 500 price-to-earnings ratio bottomed out between 15 and 16 times, so if we use that simple math, that would indicate roughly 13-14% additional downside to today's levels. But it's important to note that history is never going to absolutely repeat itself, but it might rhyme. So, I think we lose sight of the fact that there are a lot of attractive opportunities in the market today, despite the fact that sentiment is very low as people are being very cautious, and the financial media is leading you to believe that Armageddon is coming.

So, with that… I'll pose a question to Dan and Matt. What are your thoughts on a recession here in the United States?

Matthew Mondoux 18:43

I think one of the questions we get is, “Do you think we're going to have a recession?” We probably think that the more appropriate question would be, “What does the next recession look like?” Frankly, Q1 GDP was negative. And we could find out in a couple of weeks, we're currently in a recession. And if Q2 GDP comes in negative, by the generally accepted definition, we’ll have been in a recession for the first part of this year. Stock market performance would indicate we're in something similar or close to resembling a recession, if not a recession. So, what we would say is, “Okay, well, what does that look like right now?”

Well, right now, we still have low levels of unemployment. We would expect that to be probably pretty consistent through this cycle. So, we might have a recession with low unemployment. We have corporate balance sheets that are stronger than they've ever been, particularly banks. Banks have been stress-tested multiple times, not only in the depths of the pandemic but in subsequent iterations by the Fed. So, we don't expect a run on banks as we had in ’08 and ’09. The one area that could get a little soft, and maybe rightly so, would be housing. Housing has run quite a bit over the past few years, particularly since the pandemic. Higher mortgage rates could soften that market. Housing is incredibly important to GDP, and that can be something that causes a little bit of a slowdown. But we still think even if we have a recession, unemployment is going to remain fairly low. We don't expect these widespread defaults. It'll be something very, very different and more business-cycle-ish than what we saw in the financial crisis in ’08 and ’09. That would not be the expectation, given corporate balance sheet health, and individual household strong balance sheets, as well.

Dan Seder 20:41

I guess the only thing I would add is that everybody's talking about whether we're in a recession or not. Personally, I think that we are. And I know, we look at a lot of data in our Investment Committee, and it will be reported down the road. But keep in mind, the stock market leads the economy, right. So, stocks started to decline well before we saw indications in the economy. And to me, what that says is that the stock market is going to lead us out of this. So, as the media continues to spatter us and stoke fears about this recession, and ultimately, if they do report that we are in a recession, it'll likely coincide around the time when markets turn around and start to improve. So, just as the media gets more and more bearish on the economy, and the actual recession is called, the stock market is going to start leading us out of this. So I think, as long term investors, we need to stay focused, we need to stay disciplined, and recognize that we'll see a reaction in stocks before we see a reaction in the economy.

Daniel Dusina 21:51

Well said. Again plugging the Blue Chip Partners’ blog, I did put forth some pretty compelling information in terms of why a recession today would look quite different from the past three recessions. So, check out the Quarterly Edge.

Another question that we frequently get is pertaining to the fixed income market. And certainly, in times of volatility and equities, one would generally expect, as we've seen in the past, that fixed income will be the ballast of client portfolios. Unfortunately, that has not been the case this year, given the trajectory of interest rates and the monetary policy environment for the Federal Reserve. So, the question is, going forward, what are your thoughts on bonds? Are they looking more attractive than one month ago, two months ago, three months ago? Or, should there be further pain expected in the bond market? Dan, I don't know if you want to start on that one? Because we've talked about this one a fair amount in the past.

Dan Seder 22:42

Yeah, so generally, you think of the teeter-totter. So as interest rates have gone up, bond prices have dropped, so there's an inverse relationship there. And as rates go higher, bonds yield more, CDs yield more, and savings accounts at banks yield more. At a certain point, when you're in an almost zero interest rate environment, there's no yield, but those rates start to elevate, and bonds and the interest that they pay become more and more attractive. So, I would look at it as bonds today look much more attractive on a forward-looking basis than many times in the past. A lot of damage has been done. It's unfortunate that the past six months have been an environment where the bond segment of the portfolio hasn't been a ballast. Typically, when equities suffer, bonds step in and provide some stability. But again, we have to be forward-looking. And when we look at the damage that's been done in bonds, right now, I think it's an attractive opportunity. There’s an argument for there to be a bid in bonds, not to run for the fences.

Matthew Mondoux 23:55

And Dan I'll add to that. You know, we're to a point now, and this wasn't the case for a really long time, where bonds are actually yielding more than stocks, as interest rates were kind of pressed to the floor through easy money; and to Dan's point, 0% interest rates, or close to it, stocks actually had a better yield profile than investment grade bonds. Speaking specifically to that. So, we are at a point where they do yield a little bit more, which on a go-forward basis will be more attractive. And there could be some opportunity there as well as yields get a little more sizable.

Dan Seder 24:31

Daniel, how about you? Anything that you'd want to throw in there?

Daniel Dusina 24:36

Thank you, guys. I think those are all great points. What I would say is that if you have been keeping up with some of the activity that we've exhibited year to date, and client portfolios, the action in fixed income really has to be reducing duration, which is a measure of interest rate risk. So, as we start to have interest rates increasing, we want to be less exposed to that. What I would say now is that what you guys have hit on is indicative of the fact that we're starting to get paid an actual real level of income in fixed income today, which definitely was not the case over the last five years. So the fact that we're starting to actually get paid a reasonable amount for taking on interest rate risk, longer duration instruments are starting to get interesting. Especially as you think about what Dan mentioned in terms of recession, chatter picking up, and the potential for it likely in the back half of this year 2023, as well, longer-dated bonds can perform very well in that type of environment. And so, while no one wants to see longer-dated bonds off 20% in a given six-month period, it's hard to see an environment where that repeats itself over the next six months. So certainly we’re starting to see some very attractive opportunities, starting to dip our toe in the water and some of those higher-yielding instruments, not from a credit rating perspective, but more just from an income distribution perspective.

We plan to do these live webinars on a go forward basis monthly, so stay tuned for additional information as it becomes available. Please feel free to reach out to anyone on the Blue Chip Partners team for more information or if you have any questions as a follow up to this webinar.