Market insights and analysis

How dynamic, risk-managed investment solutions are performing in the current market environment

3rd Quarter | 2020

Market insights and analysis

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Updates on how dynamic, risk-managed investment solutions are performing in the current market environment.

Conquering FUD in investing

By Peter Mauthe

Recently I was listening to an interview with a marketing expert who was explaining how marketing campaigns are crafted to change the way people think, shop, and vote. The discussion really got my attention when the guest said that such campaigns are designed to escalate fear, uncertainty, and doubt among the audience. He referred to this approach as a “FUD campaign.”

As I listened to the interview, I went down two lines of thought: First, I thought back to the 12 presidential elections I have voted in. In those elections, all of the candidates’ campaigns seemed, as best I can remember, to have included this marketing approach. Second, I thought about the thousands of conversations we at Flexible Plan have every year with financial advisers and investors who are hesitant to invest because of their fears, uncertainty, and doubts about the economy, future government policies, or the direction of markets.

When investors succumb to FUD

It is understandable that investors would have fears, uncertainty, and doubt given that, just since 1976 (when I first voted for president), we have experienced six recessions, two stock market crashes, two stock market declines of more than 50%, and inflation and mortgage interest rates in the mid to high teens—and all of these through many stressful world events (see the following graph). All of these have contributed to investors making emotional decisions that too often have led them to reduce their investment holdings after markets have declined and to increase their investment holdings after markets have risen—selling low and buying high. This is not only frustrating for investors, but it also hinders them from achieving their financial goals.

The investment markets recognize the significance of these emotions that drive investor behavior—so much so that the industry designed indicators that measure fear, uncertainty, and doubt. One of these indicators is the CBOE Volatility Index (VIX), which illustrates investors’ fears about the near-term direction of the stock market. The following graph shows the path of this index over the last three years. Note that fear, as measured by this index, is highest at or near the end of market corrections. While this is understandable, this high level of fear tends to blind investors to the potential opportunities that tend to exist when fear is rampant.

The American Association of Individual Investors (AAII) designed an indicator that illustrates the level of investor pessimism or bearishness, as determined by the results of a weekly poll of individual investors (see the following graph). Notice that the highest levels of pessimism align well with the highest levels of investor fear shown in the previous graph. This shows, once again, that extreme pessimism can impede investors’ ability to be objective about their investing decisions.

The following graph shows the referenced stock market highs and lows pointed out in the previous graphs. Notice that the two most important lows, providing some of the best opportunities, were accompanied by some of the highest fear and pessimism readings among investors. It should be no surprise that the important market highs noted in this graph had some of the lowest fear and pessimism readings.

Conquering FUD with rules-based, disciplined investing

When Jerry Wagner started Flexible Plan Investments in 1981, he had already learned that fear, uncertainty, and doubt—and the bad investment decisions investors made because of those emotions—could be overcome with objective investment models.

Since then, every strategy that has been developed by Flexible Plan has been rules-based, and objective. This approach has allowed us to provide thousands of investors with disciplined and dynamic portfolio management that provides active opportunity management and active risk management.

Furthermore, every strategy has been tested extensively over market history that includes many of the economically stressful periods previously mentioned. Jerry and our Research team have also used our experience and knowledge of investor fears and the resulting volatility as component tools of many of our strategy rule sets.

As time has passed, computers have gotten more powerful, market data has become more plentiful, the securities we can invest in have become more investor-friendly, and (importantly) our knowledge and experience have grown exponentially. Today we are able to deliver portfolios that incorporate our nearly 40 years of experience in the stock, bond, and alternative markets. Our strategy-level and portfolio-level rules are tested more extensively than ever before, and we are able to offer most portfolio solutions at the lowest cost in our history.

Disciplined, dynamically risk-managed investing at work in 2020

We are now in the period after the 2020 presidential election. It also appears we are in the latter stages of COVID vaccine development. The uncertainty about both of these has kept many investors defensive for many months—during which time the stock market has recovered all of its early 2020 losses. Now many stock market indexes seem to be heading to new highs.

Our rules-based portfolios implemented defensive positions in stocks earlier this year as stock markets deteriorated. At the same time, many of our portfolios deployed opportunistic positions in government bonds since these bonds were going up sharply as stocks were declining.

As the economy languished under the weight of the COVID pandemic, our objective, rules-based strategies recognized and responded to the stock market’s recovery. This recovery by stocks in advance of an economic recovery is a common phenomenon that is recognized by many of our rules-based strategies.

At the end of September (after six months of stock market advance), many investors were still frozen by fear, uncertainty, and doubt, as represented by the $4.9 trillion in money market funds. This was $0.9 trillion more than at the end of January.

Flexible Plan does not predict the future of markets. We do respond objectively to market conditions as they develop. Note, I used the word “respond” and not “react.” Police, firefighters, and paramedics are referred to as first responders because they have a plan for every event—they do not make one up (react) once they arrive. Flexible Plan, too, has a plan to respond to market events as they happen: employing disciplined, objective, rules-based investment strategies designed to take fear, uncertainty, and doubt out of the equation.



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