I like to think that I have a personal board of directors.
You know, that group of people in your life who form the innermost circle of trust.
You're A-Team. Your posse. Your ride or dies.
People smarter than you.
The people who know much about your most personal and confidential "stuff."
Today, I am sharing an intriguing passage authored by Frank Hujsa, one of those personal board of directors.
Frank is an owner at Acadium Financial in Bonita Springs, Florida.
We can only imagine the kind of drama that he and his partners have been dealing with over the past six weeks.
The equity markets have roller coastered their way through the COVID-19 pandemic.
People's life savings and retirement planning have hung in the balance.
Complete company shutdowns and permanent closures.
Frank recently encountered someone close to him who had an interesting perspective on all this.
I don't often share the writings of others but when I read this I thought I should share it with you.
Then, perhaps you too will find some peace despite the recent market turbulence and the uncertainty of what lies ahead.
The Season of Darkness, The Spring of Hope
Last week, from the 5th to the 11th of April, 6.6 million more Americans filed for unemployment. This brings the total to over 17 million unemployment claims in the past three weeks, or roughly ten percent of the entire American workforce. Countless factories, restaurants, hotels and resorts, schools, and other small businesses have been forced to close as part of our collective national effort to limit the spread of COVID-19.
Also last week, the S&P500 rose to 2789.82. It had its single best week since 1974.
Over the Easter weekend, I was talking with a close friend of mine, who has been furloughed by his employer and is afraid that he may not get his job back at all. This contrasting data came up and he said “You need to explain that to me. The markets are crazy – it makes no sense.”
I first reminded him that the S&P500 having a good week does not mean we are out of the woods. It doesn’t tell us anything about what future weeks will contain, and doesn’t allow us to assume that the market won’t go back down.
Then I replied that whatever economic pain may lie ahead for us, that it was deliberate to a large degree. We intentionally contracted our economy and withdrew to our homes because we wanted to save as many lives as we could. Unlike past crises, people aren’t unemployed because the economy is hurting; the economy is hurting because people are unemployed. What the huge unemployment number actually might be revealing is that the master plan to thwart the virus by keeping people home is working. Kevin Drum wrote on April 2:
“The Washington Post says this is a ‘stunning sign of an economic collapse.’ EPI calls it a ‘portrait of disaster.’ That’s nonsense. It’s a deliberately engineered temporary freeze. And one of the reasons we should be able to get through it without permanent damage is that we passed a rescue bill that vastly increases unemployment benefits. We want lots of people to apply for benefits. The more the better.”
My friend agreed. But what he said next revealed the true emotional seed of his question:
“It seems wrong.”
With the human tragedy unfolding before our eyes, how could investors be happy? Is Wall Street that insanely out of touch with Main Street? At the very least, shouldn’t unemployment numbers of this magnitude have commanded some respect?
As it happened, it was my turn to agree with him. Still, his question and its emotional origin stayed with me, and I realized that many investors are likely struggling to reconcile the same apparent conflict between the market and the economy. Great investors are often required to consider things beyond their face value. The apparently conflicting data is an illusion, but is a useful illustration of three concepts that can be helpful for long-term, disciplined investors.
1. The Market Doesn’t “Care”
I don’t mean that the market is selfish or mean but that it is fundamentally emotionless. It is amoral not immoral. It considers goodness or badness as much as a traffic light considers how badly you need to use the bathroom. Markets are incredibly efficient machines at processing human sentiment. The process of determining a security’s price is the process of netting out all of the positive and negative sentiment, and rinsing out individual emotion. The S&P500 doesn’t get happy, nor does it feel fear. We do, and that is a very important distinction.
For individuals, emotions are real and they are powerful, and the overwhelming majority of market reporting targets emotion by design. For example, we never see pictures of content, sort-of-happy traders going about their day. The stock photography images of blue-jacketed Wall Street traders are alternatingly distraught and then ecstatic. They are there to make you feel happy or sad via emotional contagion, and to use this emotional hacking to drive subscriptions.
Any investor who insists upon superimposing human emotion or a moral dimension to the stock/bond market is going to be needlessly agitated and frustrated, is going to be chronically fooled by others, and runs a significant risk of sabotaging their own long-term investment outcomes.
2. Markets Look Ahead, not Back
Another important concept related to last week is that markets are influenced primarily by future data, not past data. Yesterday’s news is largely irrelevant, and the majority of events occurring today exert an unknown, probably miniscule influence on current market price movements. This is not how the financial media conditions us to think. Every single day, we are presented with headlines that connect the behavior of one index or another to events in the present or in the recent past. Thursday April 9: “Stocks End Week With Double-Digit Gains After Fed Ramps Up Emergency Lending Programs.”
This narrative is psychologically pleasing to humans because one of the defining traits of our species is that we instinctively desire explanations for everything we observe. Not being able to explain why even trivial things happened is profoundly uncomfortable to us. (I am the father of an intelligent four-year old boy, and I’m working from home. I know all about how urgent explaining trivial things can be.)
The more intellectually honest version of the above headline is far less pleasing in this sense, and so would sell far less subscriptions: “Stocks End Week With Double-Digit Gains And Nobody Really Knows Why.” We may have theories and opinions as to why the market rose last week, but trying to explain why the market went a certain way based on past or contemporaneous information is usually wrong and unhelpful. (Trying to predict what it’s going to do based on the same information is obviously even more so.)
3. It’s not Emotion, It’s Uncertainty
There are clearly times in which a particular event triggers a market reaction. Along with the present outbreak of COVID-19, September 11th 2001 and the failures of Bear Stearns and Lehman Brothers in 2007 stand out in recent memory, as do presidential elections, wars, and the like. In times like these, markets decline not because of emotion, but because of uncertainty. It’s not the event itself so much as how that event influences our collective confidence in the future. In the case of September 11th, the S&P500 did not decline in value because of grief or fury. Volatility increased and prices declined because in the chaotic time following the attacks, nobody knew how things would turn out.
As I mentioned earlier, the stock market is a vast, efficient machine that processes sentiment. If we feed a wider range of variables into the machine, the output is a lower price representing the discount that investors demand for taking on more risk. In aggregate, this is why markets “go down” when things are uncertain. In a crisis, the range of potential outcomes grows dramatically, and suddenly contains some possibilities that we are simply unprepared to handle. Stability and confidence in the future returns when these extreme outlier outcomes are eliminated by the availability of better data.
[Regarding the uncertainty of the virus at hand, the Institute for Health Metrics and Evaluation (IHME) wrote on April 5th that a “massive infusion of new data” has led to significant downward revisions in the estimated health impact and estimated need to deal with the pandemic. “As we obtain more data and more precise data, the forecasts we at IHME created have become more accurate… Regarding deaths from the virus, the Institute’s previous general analysis still stands; however the highest estimates are lower.” This means that even though the center of the bell curve has not shifted, the tails are being progressively cut off. The extremes of potential outcomes are shrinking. This is what investors need to begin regaining confidence in the future.]
At first glance, it is easy to see why it “seems wrong” that the market had its best week in nearly fifty years while unemployment numbers climbed to levels we have never seen. We insist on narratives that make sense, and which the media is happy to furnish to us. We each have real and really powerful emotions that color our perceptions. Finally, we try to use the past to explain the present, and use the present to explain the future. All of these tendencies are amplified in uncertain times, like what we are going through now.
I will end this letter to you the same way that I parted with my friend:
“I get it and I know exactly how you feel. It will work out. If anyone can handle this, I know you can. Call me if you need reinforcements. I can’t wait to get together again after this is over.”
Frank Hujsa, CFP®
Partner, Acadium Financial Partners
27499 Riverview Center Blvd, Suite 108
Bonita Springs, FL 34134
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