There is an illuminating term being tossed around the financial trade media right now, apparently coined by Warren Buffett, which summarizes well the temperamental nature of investment markets: The Broken Clock Syndrome.
Leon LaBrecque, chief strategist and founder of LJPR Financial Advisors, in Troy, Michigan, penned a blog post on the term and how it explains current market movements. As the readership will likely know, global markets are on a pretty wild ride this week, causing no small amount of investor concern and consternation. (See “Accepting Short-Term Volatility.”)
According to LaBrecque and Buffett’s theory of broken clock markets, the volatility is completely normal and is actually healthy for long-term growth prospects. “We have had seven years without a meaningful market decline of 10%,” LaBrecque observes. “That is very unusual. The market will have the tendency to overreact. We call them waves of fear and waves of greed.”
In the parlance of Warren Buffett, the clock is always either ticking slow or fast. “The market is either slow or fast,” LaBrecque continues, “and is probably only correctly valued once in a while. Seven years, coming off of the Great Recession, we’ve had a nice upward run.”
The slowing of a fast-ticking clock is a particularly apt metaphor when looking at some of the main sources of the current market frothiness. In the Chinese stock market, for example, the losses of the past month are significant, but they are dwarfed by the stellar growth the market saw in 2014.
“What changed in the last few days?” LaBrecque asks. “Is China going out of business? No. Is the U.S. economy going to collapse if China doesn’t grow at 7.4%? No. Is $40 a barrel of oil just the start, is oil going to $0? No. Is the market volatile, because it is driven by human behavior? Yes.”
NEXT: Rational corrections are good
The main message industry practitioners and pundits have been trying to impart to investors this week is simple: While the clock is slowing a bit, it’s not going to break into pieces the way it did in 2008 and 2009.
“In every year for the past 34 years, there has been a negative point in the year,” LaBrecque adds, citing figures from Morningstar. “In fact, the average of negative points for that 34 year period is -14.4%. However, in 27 out of 34 of those years, there has been a positive return, averaging 11.1%.”
Another LJPR adviser and investment manager, James Duronio, reminds his industry colleagues that the average retirement investor must be constantly instructed that trying to successfully time the market is a futile effort and even more pointless in the current environment.
“What's important to consider going forward, if you are looking at your investments from a long-term strategic perspective, is the outlook for the future,” he says. “Not a day or week from now, but over your projected investment time horizon. Direct your focus toward your plan rather than the day-to-day fluctuations of the portfolio.”
David Kelly, J.P. Morgan’s chief global strategist, earlier this year told PLANADVISER the difference between a $65,450 return over 10 years on a $10,000 initial investment and a $32,650 return in the same time period is just 10 days. In other words, the top 10 days of returns for a decade can bring in as much as half of the gross positive daily returns generated.
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Even more important, Kelly notes, is that six of the best 10 trading days for the S&P 500 between 1995 and the end of 2014 occurred within two weeks of the 10 worst days. This means an individual that routinely reacted to sharp market declines by converting his portfolio to cash and waiting two weeks or more to buy back into equities earned only half the returns of a colleague that stuck with the same portfolio and regularly rebalanced.
In more recent commentary Stewart Mather, head of independent advisory firm The Mather Group, in Chicago, reminded advisers that their clients are feeling real fear when they see the markets fluctuate this way.
“Fear of dealing with financial issues is all too common,” he notes, and it prevents otherwise capable people from making sound decisions that can help assure a comfortable retirement. One potential solution is to remind retirement investors that they are also retirement savers—to emphasize the long-term nature of portfolios, and that it’s not the right move to suspend 401(k) contributions or abandon return-seeking investments when the markets drop 5% or even 10%.
Obviously those who are imminently about to retire will need a different approach, but especially for young people just starting to save, now is the time to instill an understanding of the fundamentals.
“Having even $10,000 invested in a retirement account at age 30 will grow to nearly $45,000 by the time one reaches age 60, assuming a conservative 5% annual interest rate,” Mather concludes. “And that's without adding another dime. That's the magic of saving regularly from an early age.”