Relativity of gains and losses: pulling back the curtain
Welcome, friends. After a quick recap of the current markets and federal policy impacts on the economy, we’ll look at something that I think is often overlooked in investing, especially when essentially all asset classes are experiencing skyrocketing gains: relativity of gains and losses.
I’ve spent some time exploring the significance of time series to help us better assess investments, and relativity further provides better comparisons than the year-to-year or quarter-to-quarter snapshots that many media outlets and others currently use, and that—taken alone—can be deceiving.
This week’s key points:
The rate of individual investing is at a high, according to Business Insider, which pointed to a rise to 20%, up from previous highs of 15%.
Housing, as an asset class, also reflects the current bull market optimism, which is seen in soaring home sale prices.
It’s essential that investors consider the fuller picture of the current bull market, which means looking at how the markets are doing, relative to points in time that more accurately reflect the rise. This is critical because a look at historical behaviors shows that, when people invest with the current exuberance, things typically haven’t ended well for many of them.
A quick look at the markets
We’re at a point in history unlike any that we’ve known. There’s a light at the end of the pandemic tunnel, and we’re ready to burst into a semblance of normal life again, and the optimism we’re feeling after a period of trauma is reflected throughout the markets.
What may be different this time are both the numbers of people investing and the resulting record-upon-record gains we hear about nearly every day. While this sounds fun, what I find disconcerting is this: when investors jump in at relatively high rates and averages move up accordingly, the risks involved similarly increase.
Take a look at a snippet from a recent Wall Street Journal article, “What Happens When Stocks Only Go Up.” As the article states:
“Bear markets haven’t gone extinct. They’ve evolved into teddy bears.
That’s what some investors seem to believe—and who can blame them? The stock market used to take years, sometimes decades, to recover its prior peak after the start of a bear market decline. After last year’s 34% meltdown, however, stocks regained record highs in only 126 trading days.”
I suspect that the current volatility and exuberance isn’t sustainable. It may go on for a while still, barring any surprises on the horizon, but it simply has to settle down to function well. Inflation will likely slow things a bit, as will a return to a more normal day-to-day life, when people are back at work and the federal government ends the monetary safety nets that it (rightly, overall) threw to most Americans over the last year.
According to The Conference Board survey, “American Consumers Turn to Stock Market Amid Pandemic Restrictions and Stimulus”:
“Record-high stock valuations—and fewer things to spend on as COVID-19 restrictions enter a second year—are enticing more US consumers to invest discretionary funds in the stock market. In Q4 2020, 20% of consumers surveyed invested in shares of stocks or mutual funds, up from 16% in Q2. By contrast, record-low interest rates have resulted in just 43% of consumers putting money into savings in Q4—down from 49% in Q2.”
In my opinion, it’s important to note that this is an area in which economic disparities have grown further, as this is an issue that will continue to challenge our country.
For millions of people who lost low-paying jobs, the stimulus funds kept roofs over heads and food on tables. For the rest, it was a gift from the government and they had nothing to lose, really, by gambling with it. As noted in the New York Times, “Although the distribution of income is unequal in the United States, ownership of financial assets in general and stocks in particular is even more so.”
And while massive federal investment in infrastructure would be a tremendous boost for employment and a huge range of industries, as well as a significant long-term benefit for our country, both whether that will come to fruition and how it will be paid for are still up in the air.
Another unknown that could have an impact is resistance in the U.S. to vaccinations. With about half of the country now immunized and the rest holding out, analysts say that herd immunity is unlikely here.
What does that mean for our long-term recovery if half of the people won’t protect themselves and others?
Health and mortality issues aside, this isn’t great news for the markets and the economic recovery as a whole. What’s the solution? Potential programs like vaccine passports and proof of vaccination or COVID-test results are controversial in the face of individual rights and privacy issues. Short of getting more people vaccinated, I don’t know the answer.
Relativity and the markets
With a high number of individuals jumping into the markets, it’s important that we look at current results relative to highs and lows to understand how things are going.
Here’s why I say this. For any investment, when you make it is your base point. So, for new investors who have just come in since about July 2020, many have only experienced upswings. For all the rest (and for the new investors, going forward), you need to look, not only at market performance over the last year or couple of quarters, but where you were when you entered the markets. Then compare that to now.
For example, if you bought a stock for $1 in December 2019, it likely dropped significantly at the start of the pandemic, let’s say 30%. That would make your investment worth about 70 cents a year ago. In the time since, it may have risen 35%, which sounds fantastic. But in actuality, an increase of 35% on your investment, which stood at 70 cents, gets you back to 94.5 cents—not even back to where you started. You’d need an increase of about 43% just to get back to your original $1 investment. Any increases above that get you back in positive territory.
That, friends, is a substantial jump. And this is why I say that while the markets seem to be going like gangbusters, what that actually means for people is much more nuanced.
Here’s a real-life example: As reported on CBSNews.com, “On March 23, 2020, the S&P 500 fell 2.9%. In all, the index dropped nearly 34% in about a month, wiping out three years' worth of gains for the market.”
The article continues, “It all led to a 76.1% surge for the S&P 500 and a shocking return to record heights. This run looks to be one of the, if not the, best 365-day stretches for the S&P 500 since before World War II.”
It’s like the Wizard of Oz threw magic dust on the markets. And here’s where I try to help you be smarter investors by pulling back the curtain.
Let’s say that you invested $1 in the S&P 500 in December 2019, before the first real impacts of the pandemic. On March 23, 2020, your investment would be worth approximately 66 cents (give or take a bit for activity between December and March 23). So now, even with a whopping 76% gain, your investment of $1 is worth about $1.16.
Don’t get me wrong—a gain of 16% in about 15 months is still a terrific return. But with any type of investment, you have to look at it relative to a broader timeframe, especially when the year-over-year statistics include an event unlike any that we’ve experienced.
I bring this up, because every day, I hear people reiterating the percentage-gains that they hear in the news and they seem to misunderstand what it actually means for them. This kind of thinking further contributes to the incredible rates at which people are investing and it can lead to some poor decisions.
And I think that new and younger investors are particularly at risk, because they’ve only known upswings. As was pointed out in the CBS article I cited earlier, “Clients under the age of 40 accounted for 35% of trading last month at Charles Schwab, nearly double the rate of two years earlier. Accounts less than a year old are doing more trading in total at Charles Schwab than accounts that have been around more than 10 years.”
I’m not saying this because I think that young, new or exuberant investors don’t know what they’re doing—they’re just as capable as anyone else at playing the market well. But from decades as a trader and investor, I also know how easy it is to lose track of relativity in investing.
If you really want to determine whether you’ve made money, you need to look at it relative to a broader time series to determine what you’ve gained and lost over time. When you do, you’ll have a much more accurate picture of how you’re doing and you’ll be a smarter investor as you move forward.
Residential real estate
Along with the stock markets, I think we need to do some relative thinking in residential real estate. I say this because, along with all of the challenges to buying homes right now (which I’ve discussed many times in this blog), there’s a lot of media frenzy about the “hottest” markets and other hyperbolic labels.
Yes, people have bought homes in droves in areas outside of major urban centers, aka in suburbs and rural areas. Yes, some of those were sleepy outliers (and happily so) that had existed relatively undiscovered. During the pandemic, when we could work anywhere and wanted more space everywhere, word got out about these locales and before long, if you believe the media, about half of Californians headed for Austin, TX while the rest went to Coeur d’Alene, ID.
What denotes a hyperbolic label, though, can be as non-scientific as something that a few people said on social media that suddenly caught steam or something more data-driven, as the Wall Street Journal tried to explain in the article, “See the Full Rankings for WSJ/Realtor.com’s Emerging Housing Markets Index.”
Keep in mind that today’s hot markets are all relative to one unprecedented driver: the pandemic (and the desire to escape it). While one year on, millions of people say that they want to work from home forever and they want their homes to be in the spacious yards of Idaho, it’s highly likely that we’ll see some migration back from the hills to urban and coastal enclaves once the pandemic scare is more fully in the rear-view mirror.
It’s likely, too, that many of today’s youth will grow up and, like their parents and grandparents before them, they’ll head to the cities for a different set of quality-of-life reasons. Between now and then, there may be some settling in some real estate prices, maybe even a slight cooling. Everything is relative.
Otherwise in residential real estate, there may be price volatility if there’s any significant movement in other equities. I’m not predicting long-term price decreases in housing, but shorter-term declines aren’t unprecedented or unexpected.
Further, complicating affordability today are the rising costs of just about everything that goes into new construction. For example, CNBC reported on data from the National Association of Home Builders that the cost of lumber—just one element of a new home—boosted the average cost of a new home by more than $36,000.
Throughout the pandemic, people invested heavily in their homes and this trend is likely to continue, although the availability of materials and labor, coupled with increased costs overall, will probably slow things a bit. As a result, people may have to choose between the inground pool, the home office addition, or the new kitchen… for now.
And it gives me great joy to say that, as Plunk builds out its reach, it’ll be able to make those decisions wisely, with data-driven insight.
Have a good week.
