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Staying Dynamic
How can we avoid traditionally wrong market theories while guarding against new, unproven hypotheses? Learn to walk the fine line between the two.
Daniel Lancaster
December 02, 2024
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“Obey the principles without being bound by them.”
-Bruce Lee
NEWS
What Happened Last Week
October inflation numbers were in line with expectations, with the Personal Consumer Expenditure (PCE) showing an annualized 2.3% (slightly above the Fed’s long-term target average of 2%).
President-elect Trump proposed tariffs on Canada and Mexico from day 1 unless they’re willing to crack down on illegal crossings, fentanyl and crime coming across the border.
Israel and Hezbollah (based in Lebanon) reached a ceasefire deal Wednesday which allows two months for both sides to move troops out of Southern Lebanon. High tensions remain after 14 months of fighting.
Bank lending has slowed in Q4 but remains better than last year. Banks overall have reduced standards to lending, which means they have more willingness to lend now than last year. Lending fuels economic growth.
Investor sentiment is divided. Investors act as though they anticipate a strong market ahead, but a larger number of them voice concerns about a potential negative market over the next six months, according to the AAII Investor Sentiment Survey and Fear and Greed Index.
How I See It
Economic news continues to be a slight net positive, while sentiment is divided.
The main issues that raise investor concerns are threats of Russian aggression, closely watched inflation numbers, and speculation over the implementation and impact of tariffs.
That said, markets continue to bet on significant earnings growth over the next few years.
Decreasing regulation while increasing demand through tax cuts and the integration of AI technologies might be able to deliver the necessary growth. But according to stock pricing, it sure looks like the bar has been set high.
It seems to me that markets are already making their bets on this.
At present, I see 2025 potentially being a below average year. An average positive year is about 20%-23%.
And because expectations appear to be high, I suspect within the next six months there will be heightened volatility. My guess is we could even see a relatively quick drop of 10%-15% over some perceived negative which makes its way through the news outlets.
But I don’t believe we’re headed into a bear market, which is a long and deep downturn. We’ll have to watch closely for signs of real fundamental deterioration, but presently that doesn’t appear likely.
There’s just too much overall positive economic growth and potential, combined with monetary policy from the Federal Reserve and restrained investor sentiment.
Corrections are not a time to radically change risk factors. They cannot be effectively timed on a consistent basis. And because they only last a few months on average, it’s better to ride through them rather than risk getting out (and back in) at the wrong time.
We will have to watch closely to determine if the months ahead show inklings of a bear market beginning. But as of now, I believe this bull market has room to run through the end of next year, even if the positive returns may be below average next year.
Put options, which are relatively cheaper at the moment compared with the last six months, can help reduce some of that downside volatility for those who don’t want the full risk.
Focusing on beta can offer additional help in navigating risk. Check out the Financial Tool below to read more!
PARADIGM SHIFT
Staying Dynamic
In his book The Hero With a Thousand Faces, author Joseph Campbell breaks down the common metanarrative that emerges in every story that has stood the test of time.
He discusses one recurring theme, which is the constant struggle of the old ways against the new. In story, this is often characterized by the traditions of the father figure at odds with the idealism of the visionary son. There is a trap of falling into routine because it’s the way things have always been done.
But even if the new ways win over the old, those new ways run the risk of becoming old, stale and systematized in a way that stifles their effectiveness (just like the old ways). “The hero of yesterday [if not careful] becomes the tyrant of tomorrow,” he says. If we’re not vigilant and dynamic, we will elevate the new ways above the old ways until we fall right back into the same trap of mindless adherence to the new tradition.
While much could be said about the depth of this insight, I want to compare it to something more toward the surface of things.
With investing, there are two things we must watch out for.
1.) Relying on commonly accepted “wisdom” simply because it “makes sense.”
2.) Chasing new fads or the latest hot stock trend because it’s going to change everything.
Question traditional thinking but be cautious of new hype.
How do you do that?
1.) When faced with a new hypothesis (X causes Y), never assume its truth just because the logic intrinsically makes sense to you.
2.) Where you can, test the hypothesis from similar periods of past history. How often do X and Y occur together compared with how often they do not?
3.) Where you don’t have access, time or the knowledge to test, research third parties that have tested the hypothesis and read at least two conflicting viewpoints.
4.) When you hear about an investment opportunity that’s going ballistic, don’t immediately go all in just because it makes sense to you. Ask, “What if I’m wrong and the high returns go the opposite direction?” and “Is this strategy becoming more and more popular?” Past returns have very little correlation with future returns, as much as it can appear that they do at first glance.
The biggest defense against clinging to wrong traditions or getting caught up in new failing gambles is to arm yourself with financial literacy and education.
No matter how comfortable you become with investing theory, always be ready to slay the old ideas when they are no longer proven to work.
And embrace only those new ideas which have a solid foundation that make intrinsic sense and align with provable historical precedence.
FINANCIAL TOOL
Beta
How volatile is your stock or fund likely to be?
More importantly, how likely is it to move more or less than the overall market?
That’s where beta helps you determine whether a stock or fund meets your need or desire for risk.
Here’s the technical definition. Don’t worry, you don’t need to memorize this to use its answer!
Beta =
Covariance of stock returns vs benchmark returns
Variance of benchmark returns
The beta can range from -1 to 1.
A beta of 1 means it has historically moved $1 for every $1 move in the benchmark (like the S&P 500).
A beta of -1 means it has historically moved exactly opposite to the market: negative $1 for every positive $1 move in the benchmark.
So imagine you want to invest but don’t want the full risk of the market. Maybe you’re comfortable with 80% of typical market movement, but not 100%.
Then one factor you can look for in a group of stocks or a fund is a beta equal to 0.8. This indicates that it has historically moved about $0.80 for every $1 move in the market.
Remember that this number uses past pricing data. It is not a prediction of future price movement. But without knowing the future, it’s a good indicator among many that you can use when selecting how much market risk to take on.
HERE’S HOW I CAN HELP
COURSE 1 OF 3 IS AVAILABLE FOR ENROLLMENT!
I am in the process of creating three in-depth digital courses that comprehensively will make you a master of your financial destiny.
The first course, called Low Risk Investing, is available and ready for enrollment. This lays a solid foundation for risk management and everything else investing.
Understanding and utilizing these strategies will give you confidence in knowing exactly what risk to take and why. It will also show you how to eliminate the unnecessary and unwanted risks while maintaining great potential for returns.
These are pre-recorded courses that you can follow at your own pace.
What you'll get with over 3.5 hours of content:
Learn to identify the main risks of investing.
Discover the financial tools, products and strategies at your fingertips.
Determine the risk factors you want to reduce.
Learn how to build a diversified portfolio that weights the odds of success heavily in your favor!
Access a risk tolerance questionnaire, a quick guide to low risk investments, a list of scenarios paired with low risk portfolios, and a list of companies where you can access such strategies.
I’d love to hear from you. Let me know what you’d like to see in upcoming newsletters, articles, or a digital course at Contact Us - The Wealth Expedition.