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What we can learn from Black Swans and Sir John Templeton

With all the talk about the Magnificent Seven Stocks (Alphabet, Amazon, Apple, Meta, Netflix, Nvidia, and Tesla) and how concentrated the S&P 500 has become – 25-30% of the index is in these seven stocks, depending on the day – I thought of periods in the past that saw bubbles and other negative market events.  Although there is small chatter about bubbles happening now, there seems to be a lack of concern in the markets about what may go wrong. 

To be clear, I am not a pessimist – quite the opposite.  Nevertheless, investors need to remain vigilant about risks. After the GFC in 2008-2009, such “black swan” discussions lasted for many years. Author and investor Nassim Taleb labeled “black swans” as events that are unpredictable, shocking, and having a significant impact on markets, economies, and politics. 

I’m not saying a black swan is imminent – they are not predictable (although those with hindsight bias may disagree!).  However, the idea is that investors who do not learn from history tend to repeat it, and there is plenty to learn about the history of completely unpredictable events.

Source:  JPM Guide to the Markets as of 4/30/34

Examples of black swans include the terrorist attacks of 9/11/2001, the previously mentioned great financial crisis, and Covid-19, among others. Black swans can cause investors significant consternation, but they also provide valuable lessons to be learned and applied. At Sunpointe, we leverage decades of behavioral finance research and experience to develop proprietary models for keeping our clients on track and investing rather than selling during upheavals.

1. Diversification. To the exact point of having too much concentration in a few stocks, investors need to ensure they have a diversified portfolio. For instance, investors should have equity investments outside of U.S. large-cap stocks. At present, US Small Cap and Mid Cap stocks are attractively valued. On the risk mitigation side, there are attractive opportunities in private credit. REITs are also selling at a material discount to NAV. Investors should have overseas exposure – while we are overweight US stocks relative to global indexes, we still recommend some exposure to non-US markets as there are still plenty of attractive companies worth owning.

“Diversification is a safety factor that is essential because we should be humble enough to admit we can be wrong.”

– Sir John Templeton

2. Mad Money Account. It is quite common for investors to invest in individual stocks that may be risky. However, too heavy a weight to any (or a few) individual stocks can skew the returns of an entire portfolio. For investors who like investing in individual names, we advise creating a small “Mad Money” account. This account might represent between 1% and 5% of overall wealth depending upon multiple factors such as risk tolerance, investment knowledge, and time horizon. With this approach, if things work out on that account, that’s great! If not, the investor has the bulk of their assets in a long-term, diversified portfolio.

“Whenever you get a wild excess on the upside, the following correction doesn’t just go back to normal; it almost always falls way below normal.”

– Sir John Templeton

3. Buy Low, Sell High. Chaos can lead to opportunity. From a behavioral finance perspective, this is counter-intuitive, as most people think about selling when markets fall. Nothing could be further from the right approach. Perhaps the most common phrase in finance is “buy low, sell high”. This seems simple, but in practice, it is difficult to implement even though it is the right approach over the long term. Another phrase I like is “time in the market is more important than timing in the market.”

“There will be bear markets about twice every ten years and recessions about twice every 10 or 12 years but nobody has been able to predict them reliably. So, the best thing to do is to buy when shares are thoroughly depressed and that means when other people are selling.”

– Sir John Templeton

At Sunpointe, we have developed behavioral optimization models to ensure that clients can understand how much risk they are taking and when to add or subtract risk from their portfolio. These models determine an appropriate allocation to risky assets based on valuations and a client’s investment objective. By doing so, we can leave room for portfolios to add risk during upheavals and trim risk during periods of market enthusiasm.

If you’re interested in learning more about how our behavioral finance focused approach helps client’s weather unpredictable markets, please reach out to our team. We will walk you through how we work with clients.