Trading Desk: Turn The Page And Pivot The Portfolio

A lot of investors cultivate sentimental or even superstitious relationships to the Wall Street calendar and all its seasonal, cyclical, statistical intricacies . . . but for me, the lesson is a lot more direct. Time never stands still. Your money shouldn’t either.

That’s especially important to reflect on as we close the calendar on the third-worst year for stocks in the last half century. The S&P 500 ends the year still on the edge of the 20% bear zone. The NASDAQ is down almost 34% from its peak.

That’s the kind of retreat we haven’t seen since the 2008 crash. And most people just haven’t lived through other market event this severe, so that’s the benchmark they naturally flash back to in an effort to put the losses into a historical context.

But I’ve lived through this kind of market weather in the past and I’ve talked to people who were around before I was paying attention. Years like this are never the end of the world. While they’re usually a sign that the economic wind is changing, that’s usually more of an opportunity than anything else . . . provided you’re willing to bend with the wind.

A Long Way Up The Mountain

Start with a fresh sense of how long it’s been since the 2008 crash and how far the market has come in the intervening decade and a half.

Starting at the end of 2008 and ending at the end of 2021, the S&P 500 soared 450%. Every $100 in the market in the wake of the crash was worth a heady $550 a year ago.

It translates into roughly a 14% compound annualized return over the period, which is better than the 8-11% we usually expect in the long haul. And even now, what was once $550 in investor wealth a year ago is still worth $439 . . . taking that outsize return rate back down to 11%.

In other words, all the bears have done was set the market back a couple of years. Stocks got a few years ahead of their fundamentals and needed a reality check.

And yet if history isn’t broken, 2023 will probably take long-term investors back to $550 for every $100 they had in the market 15 years previously. All the damage left behind in one of the worst years in memory will be gone.

The pain will linger. But investing is not about letting past trauma run your portfolio. It’s about standing up again and getting back on the field when the game knocks you down.

Maybe you saw your net worth cut in half in the 2008 crash. That’s fair. In that scenario, the $100 you were left with at the end of the year was just the miserable remnant of what had been $180 in late 2007.

Someone who was feeling good at $180 would still feel more than a little bitter at $100. They wouldn’t be back at $180 until late in 2012. That’s why it’s important to keep the portfolio rotating.

The Economic Cycle

After all, the economy is not a steady equilibrium punctuated with shocks. It’s a cycle where the sweet spot changes depending on whether you’re in a boom or a bust.

Remember, that’s where the current bear market came from. Investors are anticipating a recession. That’s when the economic cycle peaks and then deflates. And after the recession, a new boom begins.

An investor who took a 45% loss in 2008 could have repaired all the damage and come out a little ahead in two years . . . provided he or she was willing to cash out the big stocks that had stopped working and push everything into small caps.

I did something similar back then. Going small meant going back to the areas of the economy that had gotten ignored in the lead up to the crash: healthcare, the industrials, even the Silicon Valley names that had been abandoned after the dot-com bubble era.

And while I can’t promise that something similar will play out in the near future, history suggests that there’s always a smart rotation that can repair damage and get back to work faster than a buy-and-hold strategy.

The logic is as simple as it gets. The stocks we held going into a drop already proved that they don’t have what it takes to defend themselves in the eyes of investors. Unless the companies themselves are transformed, there’s no point in hoping the market’s response to the stocks will change.

To engineer real change, you need to change the portfolio. I did that in 2008, taking what was left of my accumulated gains from the previous boom and rolling into overlooked and unloved stocks ready to become leaders.

I did it in 2000-2 as well. At the time, someone who bought in at the 1999 peak was looking at a 37% loss by the end of 2002. If they had $100 in the dot-com boom, they had just $63 left three short years later.

But I didn’t buy the top. Someone who had the courage to buy in 1994 and hang on would have quintupled the starting stake by the time the year 2000 rolled around and stocks went south.

They might have invested $100 at the beginning of the cycle but even a 37% haircut would have left them with about $280. They were well ahead of the curve, a little less rich on paper without staring at a tangible loss.

And the timetable played out very similarly back then. If you refused to rotate the portfolio, you wouldn’t repair the dot-com losses before mid-2006. Roll back into small caps in 2002 and you’d be whole before the end of 2004 . . . two years early.

In fact, someone who rolled into small caps after the dot-com crash beat the broad market by about 1 percentage point a year. That doesn’t look huge but when you compound it across decades, it’s the difference between tripling and quadrupling your money across the economic cycle.

If you’re not happy with the random walk, that’s what it takes. It’s what we do here. And we’re going to see the results in the new year.

A lot of people’s accounts are bleeding. Time to apply the medicine and the bandages . . . not to dwell on the past but to thrive in the future.