October strikes fear into the hearts of many Wall Street veterans – and for good reason. Over the past 123 years, 7 of the 10 worst days in US stock market history have occurred during this seemingly haunted 31-day period.
But there is nothing supernatural in these scares of October: they are the vestiges of the 19th century agricultural finance cycle. During the 1800s, farmers harvested and shipped their crops to market in the fall, paying for the operation with large withdrawals from their local banks. These banks, in turn, withdrew funds from major New York banks and trusts to replenish their reserves, which made Wall Street financial markets particularly vulnerable to panics. Even after the United States transitioned to an industrial economy and reestablished a central banking system in the early 1900s, memories of past Octobers seem to have conditioned investors to panic out of habit. October 2022 may just be the last manifestation.
Closet Tactical Asset Allocation Costs
Panic is the mortal enemy of long-term investors, especially in volatile markets, but that doesn’t mean we should sit idly by in the face of yet another October scare. At times like these, the late David Swensen‘s observation in his classic Unconventional success worth remembering:
“Perhaps the most frequent variant of market timing comes not in the form of explicit bets for and against asset classes, but in the form of passive drifting away from target allocations.”
Many investors ignore this advice just when it is most valuable. Instead, they let their gains rise in bull markets and then freeze when the markets drop into bearish territory. This is precisely the insidious form of tactical asset allocation that Swensen refers to.
But history shows that this is never wise. For every scholar who successfully navigates the treacherous macroeconomic currents, many more suffer financial ruin trying. Failure to rebalance may not be ruinous, but it will almost certainly lead to lower long-term returns.
Dow Jones Industrial Average: 10 worst trading days:
|Decline of a day
|October 19, 1987
|October 28, 1929
|October 29, 1929
|December 18, 1899
|March 14, 1907
|October 26, 1987
|October 15, 2008
|October 18, 1937
|December 1, 2008
|October 8, 2008
So why is such tactical asset allocation so common among pension funds, foundations, endowments and other institutional investors? Since many are advised by non-discretionary investment advisers who do not have the authority to rebalance portfolios, they simply neglect to advise their clients to do so. But admins need to take the initiative and make sure they follow through on rebalancing at times like these.
Short term pain and long term gain
In Principles, Ray Dalio advises readers to seek out painful commentary so they can confront their deficits and gain the insight needed to eliminate them. He often repeats the mantra: Pain + Reflection = Progress. Economic events follow a similar principle. The current economic difficulties will likely intensify in the coming months, but that does not mean that we are suffering unnecessarily. Past mistakes must be corrected. High inflation has persisted for too long and restoring price stability is absolutely essential to ensure future economic prosperity. We learned it in the 1980s. There is no need to learn it again in the 2020s. We have to break the back of inflation, and while it will be painful, it will be worth it.
Today’s difficulties will not be in vain. After the recession of 1981 and 1982, the American economy came back stronger. Fueled by extraordinary technological innovation, the country has enjoyed two decades of economic prosperity.
The last two and a half years have been marked by many financial scares. We may see more in October and in the months to come. But when it passes, we will breathe freely again. In the meantime, we must steel our nerves, rebalance our wallets, and believe that the pain we are going through now will be rewarded in the future.
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All posts are the opinion of the author. As such, they should not be construed as investment advice, and the opinions expressed do not necessarily reflect the views of the CFA Institute or the author’s employer.
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