Extremes Trump Tranquility

“All truth passes through three stages. First, it is ridiculed. Second, it is violently opposed. Third, it is accepted as being self-evident.” – Arthur Schopenhauer

The degree to which misinformation is spread and believed is remarkable, a theme I expressed in last week’s writing.  But what is even more incredible is the extent to which people fall for small sample and recency bias. The very immediate short-term past is extrapolated to the long-term future in a way that really needs to give everybody pause.  Investment decisions are based off of one-liners and one-direction, void of any serious analysis about where we are, where we’ve been, and where we have no clue we are heading.

Rather than extrapolate the recent past, let us instead set the record straight.  There are very few truisms in markets, but there are absolute truths.  The two most powerful absolute truths? Consistency of strong performance is a lie, and volatility is perhaps the most mean-reverting aspect of market behavior.  Let me put it simply.  Anyone who tells you that they can achieve consistent outperformance (or performance period) has absolutely zero understanding of markets.  None.

Wait – you think I’m wrong?  The bull market since the low in March 2009 has been incredibly consistent and huge!  Not so fast.  Yes, the S&P 500 appears to have had consistently strong performance year after year.  But the reality is that this is an illusion.  The “consistency” of strong performance looks dramatically different if one simply removed the 10 best days of market returns.  Removing the 10 worst days results in even stronger performance than one might imagine.


As far as the cumulative return of the “incredibly consistent strong” US market, buy and hold since the March 9,2009 low in the S&P 500 SPDR ETF is 310.36%.  That return drops to 148.59% by simply removing the 10 best days of market performance.  Quite factually, 0.5% of the days since the March 2009 lows account for a differential of 1.9x in terms of that “consistently strong return” that is all the rage.  There is absolutely nothing consistent about performance when an extremely small set of days determines just how strong cumulative performance actually is.  Extreme days defines performance.  Period.

Those extreme days which define performance happen because of heightened volatility both ways. This leads us to our second truism.  Volatility is mean reverting, and every age of turbulence must be preceded by an age of moderation before it.  These cycles ARE consistent and persistent, but completely forgotten about based on the sound byte of the day.  Currently, volatility in the recent past is remarkable depressed, as Charlie Bilello, our Director of Research, points out in his excellent Twitter feed.


And here ladies and gentlemen is where the two truths cross.  Stocks feel like a can’t lose investment in the US because the most recent past has been the most tranquil in history.  But the problem is that tranquil “consistent” performance does NOT define cumulative returns.  Extreme days do.  We are in an incredible low volatility period.  There are no extremes here.  Feels great.  But as long as cycles still exist, and as long as mean reversion is as strong as gravity, then what is to come is likely an explosion higher in asset market volatility.  I suspect we are closer to that than most think.

And that – well that will define your returns.  Extremes trump tranquility.  Do not believe in the illusions of the recent past, but the facts of long-term history.

This writing is for informational purposes only and does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction, or as an offer to provide advisory or other services by Pension Partners, LLC in any jurisdiction in which such offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Pension Partners, LLC expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing.


Comments are closed.