Special CEO Report February 7, 2018
Following yesterday’s record drop on Wall Street, the S&P 500’s price return for the past 12 months was “only” 15.5% (per today’s Wall Street Journal). If we ignored the magnitude of an over 1,000-point drop to the Dow Jones Industrial Average this week, we would be pleased with a return that is in excess of the historical annual return of the S&P 500’s 10.5% So what happened?
Since the presidential election in November 2016, the S&P 500 has steadily increased with little volatility. When there are extended periods of risky assets increasing without exhibiting the outward volatility expected with these assets, investors have a tendency to become complacent.
Why now? Isn’t the economy strengthening, companies releasing positive earnings reports, and finally an increase in wage growth? Unfortunately, too much good news is not necessarily good for the stock market. All the positive news accelerated the trend towards increased interest rates, fueling inflation concerns. Investors had become comfortable with yields from stocks (versus bonds) even with the increased risk (remember investor complacency about risk?). When bond yields started rising faster than previous market expectations, inflation concerns took the front stage and investors began to move out of stocks and into bonds. Expectations of the Federal Reserve increasing interest rates at a faster pace because of all this good news became an additional concern for investors.
Is there anything else impacting the volatility in the stock market? I believe behavioral finance plays an important part in significant swings in markets, whether we are talking stocks, bonds, or other financial markets. Fear and greed are particularly dangerous antagonists for investors. Seeing the market drop and wanting out (selling low) or seeing their friends make a lot of money and they are missing out (stocks without “current” volatility, buying high, Bitcoin) are emotionally driven. Behavioral finance protection is one of the most important protections your wealth advisor at Petersen Hastings provides to you as part of our services. If you have any concerns or questions about navigating the complicated investing waters we are currently experiencing, we encourage you to call us. Your advisor will be able to help you understand any action (or inaction) that is in your best interest.
What is all of this excitement about Bitcoin? We have been seeing a decline in the Bitcoin price recently, especially since governments and regulatory agencies have publicly become increasingly concerned about the public benefit of the decentralized digital currency system. In the previous special report, I commented about how investors have become complacent about risk. While I do not believe Bitcoin is responsible for our recent stock market volatility, I do believe it is symptomatic of our complacency about risk. Warren Buffett said it well last month, “What’s going on (Bitcoin) definitely will come to a bad ending.”
The big red flag for me was the increasing interest in Bitcoin. Why would anyone, other than those that are interested in keeping their identities private, speculate in something that does not exhibit the characteristic of a reliable monetary form of payment. The answer may explain the potential unwinding that we are witnessing. We know that there are unsophisticated investors that want to participate in anything that is considered “anti-government.” While this group may be quite vocal, it is hard to believe it represents significant wealth to fuel this massive game of speculation. The group that may be the key to the rate of unwinding are those playing a high stakes game of “musical chairs.” This group could represent significant wealth, be well aware of the risks that are involved, and have confidence that they have the skill to get in and out of Bitcoin at a profit. Once this group loses confidence in Bitcoin, it could (or maybe already has) result in the last chapter being written about this decentralized digital currency system. After over 30 years in the business, it looks, smells, and feels a lot like a Ponzi scheme, but maybe I will be proven wrong. That being said, do not count on my speculation in Bitcoin!
Footnote: While we express our concern about Bitcoin, it is important to distinguish between the speculative Bitcoin and the underlying technology, “Blockchain,” that is an important emerging technology.
*Source: Morningstar Direct; Average return of the S&P 500 from 3/31/1936 to 2/5/2018