A Breakthrough In Understanding Stock Market Risk
Now, perhaps more than ever, people need a reliable approach to protecting their life savings. Both in his academic training – MBA from The University of Chicago (now called Chicago Booth) – and in his professional training– CERTIFIED FINANCIAL PLANNER® professional since 1983, Richard Coe has been taught that any attempt to time the stock market is futile. However, in recent years, Coe has begun to question some long-held academic conclusions.
In October 2015, Coe gave a presentation to the Wichita Estate Planning Council, an audience of about 70 estate planning attorneys, CPAs, trust officers, CLUs and CERTIFIED FINANCIAL PLANNER® professionals. He explained what to him has been a startling breakthrough in his understanding of how the stock market actually works.
“What is missing from the standard investment models that most financial advisors embrace?” he asked. According to Coe, investment models and strategies typically do not evidence any understanding of how the business cycle affects portfolio risk. Risk has been regarded as random and as a constant.
Coe has been on a steep stock market learning curve over the last 18 months, and he has concluded that stock market risk is not random – it is at least partially predictable. And, it is not constant – it varies significantly with changes in the business cycle.
What does this mean for investors? Coe advocates, and Coe Financial Services has now embraced, the “Condition Based Management” philosophy. The idea is to take advantage of the great growth engine known as the stock market during bullish conditions, but seek protection through bonds during recession markets. The key is knowing the existing market condition.
According to Coe, the public often has a better understanding of stock market risk than investment professionals, many of whom think of the risk factor in terms of a bell-shaped curve. “The stock market can be far more risky than suggested by a bell shaped curve,” said Coe. “People in or near retirement generally understand that large portfolio losses need to be avoided and that a passive strategy that does not actively manage risk does not make much sense.”
Is it really possible to prosper from the stock market in good times and be protected from it in bad times? Professors, investment professionals, and investors are currently divided on this issue. Coe understands and respects those who believe the answer is “No.” He was trained that the answer was “No” and that investors were wiser to live with bounces than to try to mitigate the bounces through timely defensive actions. Probably no one is more surprised than Coe himself that he has experienced a massive paradigm shift in his thinking about how investment portfolios should be managed.
“I have been interested in the stock market since my junior high days,” said Coe. I have tried to go through life always being ready to learn. Most of my life, frankly, I have been very skeptical regarding the value of timing strategies.
“What I have learned in the last 18 months is fascinating to me, and very exciting in terms of our ability to help people. We endorse timely defensive and offensive moves, and we can explain why.
“It all goes back to the business cycle,” Coe said. “Stock prices respond to corporate earnings. During good times, earnings increase and stock prices rise. During recessions, the economy contracts and earnings deteriorate, resulting in a drop in stock prices. Recessions are here to stay, and the benefits of avoiding recession markets are huge.”
Many people remember a line from a song in “The Music Man” – “You’ve got to know the territory.” Coe believes that by knowing the territory (market conditions) one can make much better investment decisions.
“Not only do we have many years of experience,” said Coe, “but, more importantly, we have a process that allows investors to invest with less stress.”
To provide additional support for the change in his thinking, Coe points to Charles Koch. In “Good Profit,” Koch writes, “Even though it is difficult to time the market in absolute terms, significant value can be created by understanding key drivers of variations in global equity performance and quickly adjusting the portfolio accordingly.”
Coe adds, “Charles Koch has one of the most brilliant economic minds the world has ever seen. Financial professionals would be wise to go to school on his conclusions.”
“We are excited about the opportunity to help more people, but will intentionally limit the number of new client relationships in 2016. Everyone is busy, so we want to be diligent in determining whether a new client is mutually a good fit. We are happy to do a preliminary meeting, but we do not want to move ahead unless the prospective clients are willing to make three commitments. Our process is designed to improve the odds of a good fit for a lasting relationship.”
Questions to Consider in Selecting a Financial Advisor:
Do you believe you will live to see another major stock market downturn?
How much of a decline in your portfolio are you willing to experience?
Can you imagine how much money is typically left in harm’s way when markets crumble?
If there was a better strategy than “live with the bounces”, would you want to know about it?
Do you believe there are better ways to protect your portfolio than annuities?
Do you consider it important to have a financial advisor who will initiate timely defensive moves?
Do you care enough about your portfolio to invest some time to learn how you can invest with less stress?