While there are reasons to be concerned about the health of the eight-plus-year-old bull market (historically high valuations, Federal Reserve tightening, and an economy performing below expectations), there are also arguments for optimism.
Inflation and interest rates remain low. Corporate profits continue to climb and exceed expectations. Job creation has been strong, contributing to low unemployment. Economists are projecting continued economic growth with no hint of a recession in sight.
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 is widely acknowledged to have been a very, very smart guy. I once read an interview with him that helped me to 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 (as we saw in 2008).
Here’s a key segment from the interview where Bernstein has 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. It essentially says that in making decisions under conditions of uncertainty, the consequences of being wrong must carry more weight than the probabilities of being right. You begin with something that’s obvious. But because it’s hard to accept, 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. [Emphasis added.]
By sharing Bernstein’s observations, I’m hoping to remind you that, despite the profits we’ve made in our various SMI strategies over the past few years, it’s important you don’t let complacency set in. While we believe their stellar performance bodes well for the future, mathematician Leibniz would say that’s true “only for the most part.” Not every year. Not always.
No portfolio can maximize profits during good markets and simultaneously insulate you from the inevitable bad markets. SMI’s biblical philosophy, however, can position you so the shocks aren’t overwhelming. If you will follow the priorities and guidelines God has provided for your protection, your finances will be resting on a strong foundation. One such guideline: “The plans of the diligent lead to profit as surely as haste leads to poverty” (Proverbs 21:5).
A key to building that strong foundation is having a personalized plan in place. It should be designed to achieve your financial goals, taking into account the occasional (and inevitable) bear-market shocks that befall all investors. Do you have such a plan in place?
I asked SMI's executive editor Mark Biller to write this month’s cover article to not only encourage you to create (or review) your plan, but to also show you how to stress-test it against the impact of a theoretical bear market. If you will take the time to do this now, then whether the coming months bring good or ill for the markets, your family’s financial foundation will be secure.