The SMI strategies enjoyed an excellent first half of the year, as we detail in Mid-Year Report: Volatile But Rewarding. The stock market’s gain of +10% through mid-year followed huge consecutive gains of +26%, +23%, and +17% the past three years. Looking ahead, the most important catalyst for continued gains — accelerating earnings growth across a broadening range of companies — continues as businesses translate the promise of AI into tangible productivity gains. And it doesn’t hurt that historically, market returns have been stronger with milder pullbacks, on average, during the second half of years when stocks were up during the first half.
All this works to reinforce my normal sunny optimism. Of course, there are some factors I haven’t taken into account — those pesky unknown events hidden in the future. That could be a problem, a potentially big problem, according to the late Peter Bernstein, author of the critically acclaimed history of financial risk, Against the Gods.
Bernstein, who died in 2009 at age 90, was widely acknowledged to be a very, very smart guy. Reading and listening to him around the time his classic book came out helped me realize that — while not wanting to worry you — I should probably do more to balance my optimism with occasional reminders that risk is real and things may not work out at all like we expect.
Here’s a key segment from an interview I noted in SMI years ago where Bernstein had just been asked to name the important lessons about risk from his book:
Two things. First, in 1703 the mathematician Gottfried von Leibniz told the scientist Jacob Bernoulli that nature does work in patterns, but “only for the most part.” The other part — the unpredictable part — tends to be where things matter the most. That’s where the action often is.
Second, “Pascal’s Wager.” [Note: In making decisions under conditions of uncertainty, the consequences of being wrong must carry more weight than the probabilities of being right]. You have to keep reminding yourself: We don’t know what’s going to happen with anything, ever. And so it’s inevitable that a certain percentage of our decisions will be wrong. There’s just no way we can always make the right decision. That doesn’t mean you’re an idiot. But it does mean you must focus on how serious the consequences could be if you turn out to be wrong: Suppose this doesn’t do what I expect it to do. What’s going to be the impact on me? If it goes wrong, how wrong could it go and how much will it matter?
Pascal’s Wager doesn’t mean that you have to be convinced beyond doubt that you are right. But you have to think about the consequences of what you’re doing and establish that you can survive them if you’re wrong. Consequences are more important than probabilities.... Risk-taking is an inevitable ingredient in investing — and in life — but never take a risk you do not have to take.
By sharing Bernstein’s observations with you, I hope to make sure that the portfolio gains we’ve enjoyed over the past few years have not allowed complacency to set in. While there is plenty of reason for optimism, mathematician von Leibniz would say that’s true “only for the most part.” Not every year. Not always.
No portfolio can maximize profits during the good times and simultaneously insulate you from the unexpected shocks the markets periodically serve up. SMI’s biblical philosophy, however, can position you so the shocks aren’t overwhelming. The instructions God has given us in His Word have proven to be practical and effective. There’s safety in following the priorities and guidelines He has provided for our protection.
It’s wise to periodically review your financial plan and make sure you’ve not wandered from the basics. That it includes an emphasis on using your monthly surplus to get debt-free and build a savings reserve. That it calls for a healthy degree of diversification (which Bernstein also encouraged). And that your portfolio mix between stocks and bonds (and any SMI-recommended alternatives) is suitable for your season of life and tolerance of risk. Then, whether the future brings good or ill for the markets, your family’s financial foundation will remain strong.
