Costly Clarity

We’ve logged a handful of positive trading sessions recently—not daily, but fairly consistently—and overall, October’s up pretty nicely so far. As we’ve said before, we believe the last several months’ market action has been more correction-like than bear market-like. So with the seeming swing recently to more positive action, is the correction over? Possibly. Or we could have more to go. Forecasting anything so near-term is near impossible and long-term ultimately not that meaningful anyway. But one thing’s certain: Waiting for further clarity before taking action (like putting idle cash to work) can be expensive in capital markets.

How so? First, we’d question what exactly “clarity” is when it comes to markets. Is it a certain number of up trading days? Some percentage move higher? A certain ratio of up stocks to down? And if it’s one of those numbers, how do you determine at what level it is meaningful? And how do you know when it’s telling you to make the opposite decision (i.e., to sell)? The reality is true clarity in markets about their future direction doesn’t exist. And if folks commonly thought it did—and that markets were clearly going to substantially rise in the future—that wouldn’t necessarily indicate a bull market ahead (see Tech bubble, 2000). All in all, if any of the above is your idea of clarity, then it isn’t really clarity you seek—it’s a pattern.

Folks like patterns. Patterns are neat. Patterns seem reliable. But patterns don’t exist for stocks in a way that’s useful because what happened yesterday, last week or last month isn’t very indicative of future direction. When you accept this point, you realize always and everywhere, investors are confronted with choices. Those choices should be underpinned by clear reasons—and an eye toward their long-term implications.

But also, once you realize patterns don’t exist, you also know volatility is an inherent, unavoidable part of markets. Sure, some investment vehicles may overall and on average swing less than others, but that doesn’t mean they don’t swing at all. Now, that’s not to say volatility isn’t a painful experience—particularly downward volatility (most folks don’t seem to mind upward volatility so much). But the problem is volatility isn’t in any way predictive. The fact stocks have been particularly volatile over the last couple months doesn’t really give you a clue as to what they’ll do over the next six, 12 or 18 months. Volatility could continue, but it could be up or down.

And if investors wait for some of the volatility to dissipate, they could wait quite a while, by which time stocks could have moved nicely up—without them. Not necessarily, but possibly. Which raises the risk the waiting game is an expensive one in the long run.

So how should investors make a decision about when to buy or sell? In our view, it should hinge, first, on what an appropriate long-term strategy is! Then, tactical moves—like near-term asset allocation shifts, shifts in size, sectors, industries, etc.—should be predicated on your view of the next 12-18 months. And that view should be built on a rational assessment of extant data and their probable implications for the future. It must also incorporate sentiment—the degree to which the probable outcome you’ve identified is being appreciated by the masses. No small task, to be sure, but an important one—and one where following the herd likely fails.

Whatever direction stocks have moved recently doesn’t impact our forward-looking assessment that, from here, it’s very likely stocks are materially higher 12 and 18 months from now. Waiting to get clarity could mean missing out on a resurging bull market—and stocks can rise fast. That form of clarity can be very expensive.