10/2024 - Asymmetric Loss Aversion
Full written article below with sources.
Asymmetric loss aversion – don’t worry if you’re not familiar with this term.
Let me explain, asymmetric loss aversion means that most of us feel the loss of something greater than we feel the gain of something.
In today’s current market environment, most clients find this to be true. I find it hard to think of a better example than now.
Ask yourself, how good to you feel to see market indexes up 20-30% over the past year. Did you even know? Because if all you do is watch the news media, I doubt you’d even have the foggiest idea this was happening. Hopefully, you feel pretty good about the market gains.
But let me ask this a different way, what is the same market indexes were down 20-30%, would you feel pretty bad or just downright terrible?
You see, in my experience, most client seem to feel “good” when markets are up and just plain terrible when they are down. This is the definition of asymmetric loss aversion.
You’re probably reading or watching this and thinking “why on earth is Dave talking about this?” Let me tell you why. We all know what I’m about to say, but you might not know the follow-up statement. The thing we all know is that this market run up isn’t going to last forever. But here’s what you might not know, in each financial plan, we expect and build into the plan the market declining. Yes, you read/heard that correct, don’t just think the market will decline, we actually plan on it declining.
When you read this, everything thinks… “well of course”… but how do we actually plan on this?
If you’re looking for details, here’s a nice chart from AmericanCentury.com which shows the market declines about 14% about every 2 years and declines about 33% about every 5 years. The informed investor will remember the last time we had a 30%+ market decline. That last decline of 30%+ was in 2020… Well, you guessed it, we’re almost 5 years from that 30% decline.
Please hear me clearly, I am NOT trying to predict a market decline in 2025. I am trying to state this clearly to all who will listen, it’s my guess the market will do what it’s historically always done, and that is move up and down. As you can see from this chart, historically, it moves up a lot more than down.
Not to distract the broader point of this newsletter, but I also do enjoy this other chart from the same source, it’s the average percent decline in a bear market and the average percent return in a bull market. Studying this chart makes me grin from ear to ear.
While I’m never going to try and “time the markets” or predict the markets, something I am watching are government regulations and federal deficits. As I see it, if the United States continues the current deficits, which may exceed the rate of growth in this great country. Then my thought is we may be left with higher taxes and increasing inflation numbers. If we do find an increasing price or cost environment, this isn’t going to help stock or bond investors.
But this is where I want to make two final points.
1. Companies: As I’m commonly stated, when we buy “stocks” what we’re really doing is buying companies. We’re owners of these said companies. These companies are tasked with the responsibility to innovate products and sell products in an effort to make a profit. So historically, when tax rates change, or inflation changes, or trade policies change, or consumer interest change, these companies change with the market conditions and historically navigate these waters to continue to increase their profitability over time. If they can’t, the company is soon no longer a company. A current example of navigating tax rates would be Chevron in moving its headquarters from California with a state corporation tax rate of 8.84% (source) to Texas with a state corporate tax rate of 0%.
2. Increasing Dividends: If we do find ourselves in an increase inflation environment, something that doesn’t seem to get enough attention is the growing dividend rate on the S&P 500 (using this has a broad market proxy). From 1950 to the end of September 2024, the S&P 500 dividend increased from 1.15% to 73.4%, which creates a rising dividend of about 5.9%, what was the inflation rate over that same period of time? It was 3.54%. Let me also cite the Annual Return of 11.49%.
But let’s look at another period where inflation was higher, from 1970 to last month, the inflation rate was 3.96% and the dividend growth rate was just about at 6%, Annual Return of 10.87%. These historical data points are just one of the reasons why I have such high conviction in owning equities, stock, “the market” or whoever else you want to define ownership in publicly traded companies. Source: https://politicalcalculations.blogspot.com/2006/12/sp-500-at-your-fingertips.html#.XFn_01xKiM8
Additional Data: Each month I get asked by clients what additional resources I’m looking at. Please hear me in stating I’m not trying to predict anything whatsoever, just some of the interesting data I’m watching.
- Personal Politics and Investing – I recently read a report from WoodleyFarra that cautioned against letting personal politics motivate investment decisions. In the report, they make a point that policy support and rhetoric doesn’t always translate into stock performance as expected. The case study looks at the performance of energy (oil & gas) stocks versus electric vehicle stocks under the Trump and Biden administrations. Energy stocks declined -42.8% while EV stocks rose 253.2% under Trump. During the Biden administration, energy stocks rose 132.8% while EV stocks declined -56.1%
- Bullish on the United States – Our great country has a slew of problems that need addressing. With that said, I’m going to encourage all readers to spend 5 minutes and read this article. I’m confident you’ll learn something new and see some silver linings.
- S&P 500 Earnings Estimates – For the people who want to get into the weeds on investment data, you’ll enjoy this research piece from FirstTrust. The articles focuses on Earnings and Revenue forecasts for 2024 and 2025. To use the words of FirstTrust, the results are “favorable”
- Trillions in Money Markets – At it’s highest level ever reported, there’s now 6.5T in money market funds. In the investing market, this is called “Dry Powder.” These are dollars enjoying higher levels of interest than in years past. But ask yourself, what do you think will happen when/if the Federal reserve starts to cut interest rates and banks start paying less in interest on these accounts? Do you really think people will just continue to hold their funds with less interest, or do you think they’ll look for other alternatives to make money? My guess is assuming interest rates come down, these people will start to move some of these funds back into the broader market. So what do you think would likely happen to market prices if this does occur?
- Breakeven Inflation Rate - 5-Year Breakeven inflation rate is now 2.11%. When you study this chart, you’ll see it goes back to 2004.
- Federal Reserve Balance sheet – The Fed continues to follow through on it’s statement made in May 2022 of reducing the balance sheet by $47.5 billion dollars per month in months June-Aug 2022, then reducing the balance sheet by $95 billion dollars per month. We’re now down to $7T dollars in the balance sheet, last time we saw this was September 2020 levels and declining.
In closing: We of course cannot control what the market does from here and we cannot predict when the next market downturn will occur. But we can control our behavior to these outside events and continue to stick with our long-term investment strategy.
As always, if you have any questions/concerns please contact me.
David Hobbs, CFP®
Wealth Advisor | Owner
Hobbs Wealth Management
**Case Study Disclosure** The case study presented is purely hypothetical and does not represent actual client results. This study is provided for educational purposes only. Similar, or even positive results, cannot be guaranteed. Each client has their own unique set of circumstances so products and strategies may not by suitable for all people. Please consult with a qualified professional before implementing any strategy discussed herein. No portion of this case study is to be interpreted as a testimonial or endorsement of the firms' investment advisory services.
Standard & Poor’s 500 (S&P 500) - a market-cap weighted index composed of the common stocks of 500 leading companies in leading industries of the U.S. economy.
Russell 2000 – The index measures the performance of the small-cap segment of the US equity universe. It is a subset of the Russell 3000 and includes approximately 2000 of the smallest securities based on a combination of their market cap and current index membership.
MSCI ACWI ex USA – The index measures the performance of the large and mid-cap segments of the particular regions, excluding USA equity securities, including developed and emerging market. It is free float-adjusted market-capitalization weighted.
Federal Funds Rate - refers to the target interest rate set by the Federal Open Market Committee (FOMC). This target is the rate at which commercial banks borrow and lend their excess reserves to each other overnight.
This report was prepared by Hobbs Wealth Management a State registered investment adviser under the Investment Advisers Act of 1940. Registration as an investment adviser does not imply a certain level of skill or training. The oral and written communications of an adviser provide you with information about which you determine to hire or retain an adviser. Neither the information nor any opinion expressed it so be construed as solicitation to buy or sell a security of personalized investment, tax, or legal advice. For more information please visit: https://adviserinfo.sec.gov/ and search for our firm name.
This newsletter is prepared to provide a degree of insight into the analysis used by Hobbs Wealth Management to make investment decisions. It is not a complete description of all factors used by Hobbs Wealth Management to make decisions on behalf of clients. The opinions included are not intended to be taken as fact, but are Hobbs Wealth Management’s interpretation of the impact of external events on investments.
The information herein was obtained from various sources. Hobbs Wealth Management does not guarantee the accuracy or completeness of information provided by third parties. The information in this report is given as of the date indicated and believed to be reliable. Hobbs Wealth Management assumes no obligation to update this information, or to advise on further developments relating to it.
This article contains external links directing you to a third-party website. Although we have reviewed the website prior to creating the link, we are not responsible for the content of the sites.
An index is an unmanaged portfolio of specific securities, the performance of which is often used as a benchmark in judging the relative performance of certain asset classes. Investors cannot invest directly in an index. An index does not charge management fees or brokerage expenses, and no such fees or expenses were deducted from the performance shown.
The mention of specific securities and sectors illustrates the application of our investment approach only and is not to be considered a recommendation. The specific securities identified and described herein do not represent all of the securities purchased or sold for the portfolio, and it should not be assumed that investment in these securities were or will be profitable. There is no assurance that the securities purchased remain in the portfolio or that securities sold have not been repurchased. For a complete list of holdings please contact your portfolio advisor.
Hobbs Wealth Management may discuss and display, charts, graphs, formulas, stock and sector picks which are not intended to be used by themselves to determine which securities to buy or sell, or when to buy or sell them. This specific information is limited and should not be used on their own to make investment decisions. This information is offered as educational only.