The last bear market was only 5 weeks long, and we’ve become complacent
For many years, the term “lower for longer” has been used to set expectations for interest rates. The crisp alliteration makes for memorable wordplay that does double duty of sticking in your mind while offering a reminder of what to expect for the next little bit.
Maybe more than just a little bit, come to think of it. Just how much longer is “longer,” anyway?
When it comes to interest rates, most people expect modest increases to begin sometime in the second half of 2022. Even then, however, rates will almost certainly be lower than they have been for most (perhaps all) of our lifetimes, for the next couple of years at least.
Depending on how long it takes for the economic environment to normalize, the new normal of “quite low for the foreseeable future” remains a distinct possibility. In speaking with other commentators, other economists and my fellow advisors, the consensus is that people should expect lower than usual interest rates for the rest of the decade and possibly even for the rest of our lives!
While that could have a massively distorting impact on the bond market, I’d like to take a moment to invite you to contemplate using the same phrase in a different context: What if markets dropped lower than you previously thought possible and stayed there for longer than you’ve ever experienced?
Investors around the world may be unwittingly complacent due to the bear market of February/March 2020 lasting only 5 weeks or so. So many people insist that they have the personal constitution and stoic disposition necessary for a prolonged market standoff, in which market levels stay low for a long time.
Will you really ‘stay the course’?
I am far less certain. Self-congratulation for staying the course when markets return to pre-drop levels within five months or so is dangerous. In fact, it borders on self-delusion.
Being able to “stay the course” requires enormous discipline and, seeing as no one I know has ever needed to demonstrate that kind of discipline in their lifetime, it really just boils down to whether you buy into the narrative.
When the bubble bursts, we won’t be able to use artificial stimulus to reinflate it.
I don’t. Don’t get me wrong, it’s not that I am wishing a lack of resolve upon investors. I hope I’m mistaken. I simply have some deep-seated doubts when people tell me they are “long term investors” when they have never, ever experienced anything like a prolonged bear market. How would they know? These paragons of focus and discipline have never really had their mettle tested.
Here’s a simple exercise. It’s a question that I asked on Twitter to see how people thought about responsible behaviour in light of an unknowable future: “Were the advisors who had clients in the Nikkei 225 in 1989 acting like fiduciaries by telling them to ‘hold for the long term’ when markets tumbled?”
Remember 1989 Japan
It’s a simple question. In case you didn’t know, the Nikkei 225 is still about 30 per cent lower today than it was at the end of 1989. There was no resolution. A large plurality said “absolutely,” an equal plurality said “absolutely not” and a few voters allowed that “fiduciary is ill-defined” and so did not take a side.
This, of course, is still hypothetical to most people. While the numbers are real, the experience is foreign. North American investors had little net worth tied up in Japanese stocks at the end of the 1980s, if they had any at all.
Try to imagine if we were to experience something only half as severe with the Canadian and/or American stock market sometime soon. Imagine being down 30 per cent from where you are today … in 2036. Let’s use actual numbers. If you had $5 million in North American stocks today, imagine that same basket of stocks being worth $3.5 million in 2036. Are you genuinely sure you can stomach that?
We’re human. We suffer from behavioural biases, including “recency bias.” Given that the rebound in 2020 was so swift and sure-footed, it’s easy to blithely think we could cope with the emotional, gut-wrenching, lifestyle-destroying sacrifices that would likely be necessary to get through a turn of events that is even remotely close to what wealthy Japanese investors have been forced to endure in our lifetime.
Government won’t have levers to pull
Markets have had a remarkably good run over the past 20 months or so. Meanwhile, there’s a broad consensus that one of the framework policies that has facilitated the strong equity markets we’ve experienced in that timeframe is prevailing interest rates. They have been lower than at any time in history, with the modest exception of the immediate aftermath of the global financial crisis of 2008-2009, when they were comparable.
“Lower for longer” rates have caused markets to go higher than many thought possible. Even if rates stay low, it is doubtful that equity markets will be able to defy gravity for much longer. When the bubble bursts, we won’t be able to use artificial stimulus to reinflate it. Interest rates can’t (really) go below zero, and governments won’t send out cheques to almost everyone once the pandemic is essentially over.
In short, when markets go down, they could stay down for a very, very long time. If you haven’t thought about what you would do in that scenario, now’s your chance. Think about it – deeply. Write things down. Be accountable to your future self. Don’t ever be caught in a situation where you need to look in the mirror and say: “I never thought this could happen to me.”