The Perils of Pessimism

In 2010 I got two client inquiries to create an “Armageddon Portfolio,” a collection of assets that would hold its value come hell or high water. Recall that we had just pulled out of the financial crisis. Many expected a repeat. For some, pessimism was so high in 2010 there was no expectation for an increase in asset value; just maintaining value was plenty. What happened next?

The world didn’t end

We did assemble an Armageddon Portfolio (AP) for those two clients. To do so, we dialed down stocks and spread more money into assets that react more calmly in turbulent times — bonds, gold, the Franc, real estate. Of course, the bull market in stocks has raged on ever since. The AP did what it was supposed to, compounding a little over 4% per year. It stayed ahead of inflation. Dividends helped. But it significantly lagged the more typical stock-rich portfolios that have performed so well since the market bottomed out almost a decade ago.

Armageddon knocking?

In 2010 many investors were worried about a double trough, a return to the financial crisis and recession that led to sharp asset declines across the board. Such worry is common among some professionals and individuals, today as then. I would not be at all surprised to get the same kind of maximum pessimism inquiry again in July 2018. The likely reasons are 1) the cycle is past due (okay, but the previous stock cycle lasted three years longer than this one) 2) our President is erratic (yes, but a large number of people think each President is erratic) 3) a world war is coming again (not impossible, but we haven’t had one for three generations) and 4) various…Fed portfolio runoff, terrorism, tariffs, interest rates, elections, foolish young people and so on.

Pessimism at your own risk

In general, we must warn against the excessive pessimism that launched the Armageddon Portfolio. There are always reasons to expect the worst and they rarely pan out. A century of investment data shows how resilient the markets are over the long term, and how hard they are to predict in the short term. It’s almost impossible to catch major turning points like peaks or valleys and it’s very tough to pick the securities that will behave exactly as you expect at those turning points. It’s certainly okay to dial down your risk if you are worried, or if your life has changed. Its prudent to ask your advisor to check and re-check your portfolio to make sure you are appropriately invested. In fact, I recommend those in all cash due to a buyout or IPO to take a gradual approach in re-investing in a diversified portfolio — patience spreads out the risk.

The reward for realism and optimism

With diversification, cash flow, frequent communication and requests for proof you can manage your way through the inevitable peaks and valleys of investing. The valleys may be sharp and deep but the peaks are higher and last longer. That is a good description of investing since the end of World War I. Right now I sense investment pessimism. And I don’t believe that a strategy primarily informed by pessimism is a good investment plan. The world rarely ends.