Much has been written regarding the current period of relative tranquility in the market. Investors have enjoyed a steady climb higher with few “gut checks” along the way. The S&P 500 Index hasn’t sustained as much as a 5% decline in the past year and a half, and if this continues into early next year, we could break the record for number of consecutive trading days since a 5% drawdown. As a sign of the relative calm pervading markets, the New York Times recently profiled a former logistics manager for a Target store in Florida who has made millions betting against volatility by shorting the Chicago Board Options Exchange Volatility Index, known as the VIX. He’s not alone in this trade as it has been very popular in recent years, in large part because it has worked.
This is not to say we haven’t had valid excuses for selloffs—the situation with North Korea comes to mind—but the market has shrugged off potential causes of disruption. In fact, the former Target manager offers a reasonable thesis that people become desensitized to bad news, resulting in downward pressure on market volatility over time. This seems particularly true in a world where news spreads quickly via various platforms, including social media.
It is worth highlighting we do have potentially disruptive risks visible on the horizon, including the Fed’s implementation of balance sheet normalization via Quantitative Tightening, but to accurately predict what will spur a resurgence of volatility is a very difficult thing to do. I won’t be so bold as to offer a prediction as to when volatility will return, though I am certain it will eventually rear its head again. Furthermore, given the tranquility to which we have become accustomed, a period of increased market fluctuation may feel particularly turbulent.
It comes as no surprise that when hiring an investment advisor, one should look for a group of intelligent, diligent individuals who can provide superior security selection. After all, this is the name of the game – pick good stocks and watch their value grow over time. However, many overlook the importance of temperament. Temperament aids in both individual stock selection as well as in helping clients stay the course by maintaining a prudent asset allocation consistent with an agreed upon long-term plan.
It is not enough for the investment advisor alone to possess the requisite temperament for investment success. It is also in clients’ best interests to respond to turbulent markets in a cool, rational manner and keep raw emotion under control. This is not always an easy thing to do when financial news tends towards sensationalism in an attempt to attract the most eyeballs. Furthermore, business news sources like CNBC (though they are far from the sole offender) report in such a way that drives people toward action – “halftime” trades and countdown clocks serve to stoke emotion and encourage action that could undermine a well-constructed long-term investment plan.
Though very far removed from a new concept, the ancient Greek and Roman philosophy of Stoicism has gained popularity in recent years. Some of this is due to the book, The Obstacle Is the Way: The Timeless Art of Turning Trials Into Triumph, released by Ryan Holiday in 2014. This book gained popularity when it was revealed it had won a broad following in the sporting world, notably with the New England Patriots. Holiday has described Stoicism as a way “to focus on managing emotion, specifically non-helpful emotion.” One can easily see how this applies to sports – if a pitcher gives up a home run, he is better served focusing on the next hitter versus getting upset and dwelling on what just occurred. The benefits of Stoicism have also been touted by well-known figures in the world of finance. Charlie Munger, Vice Chairman of Berkshire Hathaway, has praised the Stoic philosopher Epictetus. Nassim Taleb, author of The Black Swan, has consistently praised the Stoic philosophy as practiced by Seneca. It is a philosophy with broad practical application.
Though I’m not a full-blown practicing Stoic (ask my family about football Saturdays when Michigan is playing), I appreciate its positive aspects. One of the tenets of Stoicism is to focus on what you can control and ignore what you can’t. Setting a long-term plan and remaining committed to it is something you can control. Market volatility is something you can’t. I’d suggest the recent period of tranquility is a good opportunity to reaffirm your commitment to a long-term plan. This can help protect against non-helpful emotion and clouded judgment that accompanies volatility. Warren Buffett’s well known, “be greedy when others are fearful and fearful when others are greedy,” suggests an even more aggressive path in a downturn. Regardless, spending some time thinking about how you will respond can help prepare you to make the right decision when the ride we have enjoyed of late becomes a bit bumpier.
James M. Skubik, CFA