The Problem with Pessimism

In today’s hyper-connected world of news alerts, emails, tweets and Facebook posts, it can be hard to not notice all the problems in the world in 2020. Whether it’s negative political developments at home, worries of international conflict, unprecedented environmental disasters or, more recently, a global epidemic, it’s hard to be optimistic about the state of the world and where it’s heading. But why is pessimism so prevalent?

For one, it’s easy and immediate. The amount of information we’re exposed to on a daily basis is unprecedented and problems are always easier to spot in the moment, which is why the nightly news is full of negative stories on scandals, injustices and disasters. This is further exacerbated by the way that our brains operate. Not only do we tend to focus more on the negative when trying to make sense of the world, we also remember negative events more vividly than positive ones. This might be helpful when you’re trying to survive in the wilderness and avoid being eaten by predators, but overwhelming if you’re among the rest of us living in modern society.

It’s no surprise then that pessimism prevails. Sure, progress is occurring, but it can be slow and difficult to measure, even though it’s almost always very powerful over time. There are unbelievable new ideas, products, technologies, etc. that will positively impact the future in ways that we still can’t comprehend, but it’s hard to get emotional about incremental progress or abstract ideas that are hard to conceptualize. Instead, people tend to focus on the things that make them sad, angry or afraid, distorting their view of the world and their expectations for the future. It’s fairly obvious to say that this can have consequences.

Thinking about this in the context of investing, there always seems to be a reason to be pessimistic about the state of the financial markets. If you’ve ever spent time watching or reading financial media, you’ve likely come across commentary indicating that the end is nigh and the markets are set to collapse for one reason or another. Why? One factor is that the bear case is often more intellectually satisfying. Economies and financial markets are extremely complex systems, but these arguments often have one or a few compelling narratives that are used as to explain why markets are about to fall or are already falling.

One likely reason why we’ve seen so many of these arguments is that 2008 was the worst year that most investors alive today have ever experienced. The Great Financial Crisis was a generational defining event that has had financial, social and political repercussions, many of which we are still dealing with today. This shock and the permanent loss of capital that it incurred on many around the globe has been a defining force in shaping the way that current generations approach the markets and think about future returns. And over the years since the 2008 crash, we’ve seen a number of significant declines that, at the time, seemed like they might lead to another crisis.

In the moment, all of these events may have looked like reasons to pull your money and run, especially given what happened during the crisis. But in retrospect, most of these fears have been overblown.

Since the lowest point of the financial crisis until today, there have been 26 different instances of the S&P 500 Index having a sustained decline of at least 5% (including the most recent, ongoing decline due to fears of a global pandemic). Some of these declines were very significant, like the recent 20% drop at the end of 2018. Others, in retrospect, have been mild, but having experienced 2008, it should come as no surprise that a large number of people saw these drawbacks as a precursor for another crisis.

But how has the market actually performed over this entire period? From the lowest point (09.03.2009) until now (19.05.2020), the S&P 500 has gone on to provide a total return (including price changes and reinvested dividends) of 445% or 16.3% annually over the past 11 years. Once we account for the significant losses that were seen during the financial crisis, the total return of the S&P 500 from the peak of the market before the crisis (09.10.2007) until now has been 144% or 7.3% annually. How does this compare to what we’ve seen historically?

Adjusting for inflation, the total return of the S&P 500 has been about 6.2% annually from the 2007 highs until today. These numbers fall in line with long-term historical trends, as the US equity market has had a mean inflation-adjusted annual return of 6.4% between 1900 and 2018, slightly ahead of the world as a whole. We’re talking about countless instances of geopolitical crises, political and social upheaval and economic that have occurred during these years, yet the long-term averages are fairly compelling and point to steady, long-term progress. What does that mean in the literal sense? Investing in the US market, you would double the real value (after inflation) of your initial investment every 12 years at those kinds of rates.

But while this certainly looks attractive on paper, it tends to get lost in the shuffle during times of uncertainty that, in the moment, seem like they will lead to economic collapse and result in debilitating losses to an individual’s portfolio. It’s hard not turn pessimist in the face of events that may deeply impact the financial well-being of you and your family. But if we’re not wired to think about the long-term, what can we do? The first step is to adopt the proper mindset for dealing with these concerns. There are three types of risk mindsets in the world:

Those who know stuff breaks and attempt to survive the breaks long enough to experience the eventual growth that occurs when people learn and improve from the breaks.

Those who think stuff doesn’t break and are broken when it does.

Those whose experience being broken leads them to believe there’s no such thing as eventual growth.

Morgan Housel, Collaborative Fund

There’s nothing wrong with drawing conclusions about the significance of any event you believe could impact your investments. But you can’t let those conclusions impact your mindset and understanding that part of taking risk is realizing that things break once in a while, but progress will inevitably resume. Our job as asset managers is to help guide you along the way and adopt an investment strategy that helps you minimize losses when things do break while not losing sight of the long-term inevitability of progress and how to best capitalize on it.