Investors Are Ready To Capitulate

Investors Are Ready To Capitulate

Investors are ready to throw in the towel. To cry uncle. To capitulate. 

Can we blame them? This year has been brutal for both stock and bond markets. A global all-equity portfolio is down 16.87%, while a global balanced 60/40 portfolio is down 15.22% as of September 30th.

But it’s not just the double-digit losses we’ve endured this year that have investors ready to give up. It’s the non-stop barrage of negative economic sentiment that stems from persistently high inflation, the sharp rise in interest rates without a definitive end in sight, and the increasing possibility of a global recession.

How low can your investments go?

I get emails from readers and clients all the time looking for investment advice or asking me to peer into my crystal ball to let them know when it’s safe to get back into the investing waters.

The sentiment was pretty negative at the end of June, after six months of investment losses and at the height of inflation. But that was nothing compared to what I’m seeing now from investors who can’t take it any more.

This email from a reader I’ll call Nick nicely sums up what I’ve been hearing lately from investors:

“Following all the news on poor stock and bond performance, we can’t help but be concerned about a global recession that might be a lot worse than we’ve seen in recent decades. I understand the theory of staying the course but are we risking too much by staying idle?

Should we cash out the vast majority of our portfolios now, parking the funds in a 1-year GIC, and then possibly reinvest if and when all goes to shit?”

As an aside, global stocks were up roughly 5% in the two trading days since I received that email. A 1-year GIC pays 4.5% for the year. That’s how quickly things can turn around and why we stay invested for the long-term.

But I get it. Behavioural psychology teaches us that the pain of a loss is felt twice as much as the pleasure of an equal gain (loss aversion). Investors were feeling euphoric for the last three years in particular, when balanced portfolios were achieving double digit gains and all-equity portfolios were up 20% annually.

We mentally anchor to those high prices and portfolio values, and now that our investments are down 10-20% it feels like we got stung twice as hard.

While we don’t know if we’ve already reached the bottom of this bear market, or how much lower stocks and bonds will fall, we do know this pain will end at some point and that’s usually followed by a period of good returns for investors who stayed the course.

Can you take me higher?

Indeed, if you asked me at the end of 2021 what to expect for stock returns over the next decade I would have said to lower your expectations. It’s not sustainable to experience high double digit returns every year and not expect a period of poor returns to follow.

That’s not to say that I predicted a crash or anything – I’m still fully invested in 100% global equities and feeling the pain this year along with all of you.

Reversion to the mean is a powerful concept. If long-term stock returns average 8% per year, it stands to reason that after three years of 20% returns we’d see a period of underperformance to bring us back to average. That’s what we’re seeing now.

But the reverse is also true. Periods of poor investment returns are inevitably followed by periods of strong returns. We don’t know when or how quickly things will turn around, but there’s good evidence to support the idea of staying invested.

A Wealth of Common Sense blogger Ben Carlson shared why he is getting long-term bullish on stock prices. He said:

“My general investment philosophy is the more bearish things feel in the short run the more bullish I should be over the long run. If I’m taking my own advice right now I should be getting much more long run bullish.”

Carlson went on to share some charts that included periods when the S&P 500 was down 25% or more, and the subsequent 1, 3, 5, and 10 year returns that followed:

S&P Down 25%

Only the Great Financial Crisis, which saw drawdowns of 56.8% from peak to trough, had negative returns one year after reaching a 25% decline. Yes, it took some time for investments to recover but they eventually did (up 209.6% 10 years later).

As Carlson points out, stocks may fall further from here. But expected returns should be higher when prices are lower. That’s been proven after every single bear market in history.

Final thoughts

To address my reader’s point, is this time really different? Is it different than the Great Financial Crisis that nearly collapsed the entire financial sector? Is it different than the early days of a once-in-a-century pandemic when the entire world was shutting down?

Markets always find a bottom. We might not be there quite yet (who knows?) but we will get through this. We always have.

The point is, it’s not the time for investors to capitulate. You didn’t come this far to only get this far. The way you lose this game is by selling now, locking in portfolio losses of 10-20%, and missing the subsequent recovery.

After all, the only way to recover those losses over the next few years is to hold stocks (or an appropriate mix of stocks and bonds). A 4.5% GIC isn’t going to cut it.

It would be great if stocks could just deliver 6-8% a year without the extreme ups and downs. But that’s what makes investing risky (and difficult) – we get years of double digit returns, and then get walloped with a period of double digit losses. Those who stay the course have been rewarded handsomely throughout history. Why should this time be any different?

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  1. Perry Taylor on October 4, 2022 at 7:44 pm

    Thanks for the reassurance Robb. It’s tough to see the red brackets around the daily change looking at my Questrade accounts for the last several months.

  2. Freddie on October 5, 2022 at 5:42 am

    A very good summary of the situation. And you’re dead right. Don’t sell and lock in your losses. Just hang tough and ride it out. Got any cash? Go ahead and buy.

  3. Meritt on October 5, 2022 at 7:26 am

    Rob, well stated. I am holding what I have invested in stocks and continue to invest as normal. New investment has gone into the 1 year GIC’s as well as undervalued realty that has suffered a hit of high interest deterring buyers.

  4. Ron V on October 5, 2022 at 1:12 pm

    Hi Robb. What I do to get a feel for where the market is, is to look at the long term price of the Dow or TSX index over, say, 20 years (or more), with vertical axis set to logarithmic, and then mentally (or with a ruler held up to my screen) plot a line representing the mean. It is interesting to see that prices right now are close to the long term mean trend, so to my way of thinking the current correction has shaved off the highs of the last year but have not really plunged us deeply into negative territory yet. From my point of view, its not that bad right now and I would not be surprised at a brief drop into a further -8% from today’s prices. Having put aside some cash from sales done last winter, I have slowly been buying more equity etfs, but bought a bit too much too soon. I’ve spent 75% of this cash as the market went down and now I wish I had waited a bit longer. Now I’m playing a waiting game trying to time my spending the remaining 25%, and I think I might set my buy orders ranging from another 5% to 8% lower than today’s prices. That’s my idea of the bottom.

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