Markets Never Forget (But People Do)

1. Markets forget nothing, but investors forget everything

"People forget. So much! So often! So fast!"

Short-term memory plagues investors. This cognitive bias leads to myopia, where investors focus excessively on recent events and ignore long-term trends. They tend to believe that current market conditions are unique, when in reality, similar situations have occurred many times before. This forgetfulness causes investors to make the same mistakes repeatedly, such as panicking during market downturns or becoming overly optimistic during bull runs.

History is a powerful tool. By studying past market events, investors can gain perspective on current situations and make more informed decisions. For example, understanding that every recovery has been called a "jobless recovery" can help investors avoid overreacting to temporary unemployment spikes. Similarly, recognizing that fears of "double-dip" recessions are common but rarely materialize can prevent unnecessary portfolio adjustments.

2. Bull markets are inherently above average

"Bull markets are longer and stronger than people remember and above average by nature."

V-shaped recoveries are common. After bear markets, stocks often rebound sharply, forming a V-shaped pattern. The steeper the decline, the sharper the subsequent recovery tends to be. This phenomenon is driven by the disconnect between sentiment and reality at market bottoms.

Bull market characteristics:

• Average duration: 57 months
• Average cumulative return: 164%
• First 12 months average return: 46.6%
• First 3 months average return: 23.1%

Investors who miss the initial surge of a bull market due to fear or skepticism often regret it, as these early gains can account for a significant portion of the overall bull market returns.

3. Volatility is normal and volatile itself

"Volatility is volatile and not trending higher."

Volatility is a fact of market life. Despite common perceptions, market volatility is not inherently increasing over time. Instead, it fluctuates in cycles, with periods of high volatility followed by calmer periods. This pattern has remained consistent throughout market history.

Key volatility insights:

• Standard deviation (SD) of annual returns since 1926: 19.2%
• Median SD: 12.9%
• Most volatile year: 1932 (SD: 65.24%, returns: -8.41%)
• Least volatile year: 1964 (SD: 3.46%, returns: 16.48%)

Volatility is not necessarily indicative of market direction. High volatility can occur in both up and down markets. For example, 2009 was more volatile than 2008, despite being a strongly positive year for stocks.

4. Secular bear markets are a myth; secular bull markets are real

"Stocks—Up Vastly More Than Down"

Long-term market trends favor growth. Despite periodic downturns, the overall trajectory of markets is upward. This contradicts the notion of "secular bear markets" - extended periods of sustained negative returns. In reality, even during seemingly flat decades, there are significant opportunities for growth.

Historical market performance:

• Positive years: 71.8% of the time
• Positive rolling 5-year periods: 86.9%
• Positive rolling 10-year periods: 94%
• Positive rolling 20-year periods: 100%

Investors who believe in secular bear markets often miss out on substantial gains by remaining overly cautious for extended periods. Instead, recognizing the long-term upward trend of markets can help investors maintain a growth-oriented perspective.

5. Government debt fears are often overblown

"Deficits aren't bad, but surpluses will kill you."

Debt affordability matters more than size. While government debt levels can seem alarming, it's crucial to consider the cost of servicing that debt relative to the economy's size. Currently, US federal debt interest payments as a percentage of GDP are near historic lows, making the debt burden more manageable than it appears.

Key debt insights:

• Current US federal debt interest payments: ~2% of GDP
• Historical range: 1.5% to 3% of GDP (1940s-2010s)
• UK debt levels above 100% of GDP: Almost uniformly from 1750 to 1850

Historically, periods of high government debt have not necessarily led to economic stagnation. For example, the UK experienced significant economic growth and innovation during the 18th and 19th centuries despite high debt levels.

6. No single investment category is superior for all time

"Normal returns are extreme, not average."

Market leadership rotates. No single investment category, such as small-cap, large-cap, growth, or value stocks, consistently outperforms over long periods. Leadership tends to shift based on economic conditions, investor sentiment, and other factors.

Investment category insights:

• Small-cap stocks: Outperformed long-term but with significant periods of underperformance
• Growth vs. Value: Performance depends on interest rate environment
• Sector leadership: Varies based on economic cycles

Investors should avoid becoming overly attached to any single category and instead maintain a diversified portfolio that can benefit from leadership rotations. Additionally, understanding the factors that drive category performance can help in making tactical adjustments.

7. Political parties don't determine market performance

"Your party isn't better."

Market performance is not tied to political parties. Contrary to popular belief, neither Democrats nor Republicans have a consistent advantage in driving stock market returns. Instead, market performance is more closely tied to the economic and business cycle.

Presidential cycle effects:

• Years 1-2: More variable returns, average 8.1% and 9.0%
• Years 3-4: More consistently positive, average 19.4% and 10.9%

The pattern is driven by legislative risk aversion, with more significant policy changes typically occurring in the first two years of a presidential term. Investors should focus on fundamental economic factors rather than political affiliations when making investment decisions.

8. The world has always been interconnected globally

"The world has always been pretty darn global—more global than most think and for much longer than most fathom."

Global economic synchronization is not new. Economic cycles have been interconnected across major developed countries for over 200 years. This long-standing global integration contradicts the notion that globalization is a recent phenomenon.

Global market insights:

• US stocks: 43% of world market capitalization
• Non-US stocks: 57% of world market capitalization
• Average US investor's international allocation: 14.4%

Investors who ignore global opportunities miss out on potential returns and diversification benefits. A truly global perspective allows investors to capitalize on growth opportunities worldwide and better manage risk through broader diversification.

Last updated: July 28, 2024