Why is Pessimism Popular?
Key Takeaways
The sell-off of 2022 is a mere 7% away from being erased from global stocks.
The quick 20-month turnaround has many strategists changing their doomsday tune. However as a bow to investor anxiety, many new products that claim to offer capital protection while enjoying equity returns are popping up in the market.
Investors should be aware that they are giving up future returns to pay for the protection - and it has not worked all the time.
The lacklustre performance of many of these products show that the best ways of investing are ones that are time tested and backed by science.
Organisms that treat threats as more urgent than opportunities have a better chance to survive and reproduce.
At the end of 2022 and in the early part of 2023, it made sense to feel pessimistic about investing. Central banks were waging war on inflation and hiking rates; bonds had a terrible year and continued to be the most inverted in 40 years; everyone you spoke to said that a recession was coming; the tech sector began layoffs and it was assumed that it would spread to other areas.
At the time of writing — 20 months after the sell-off began — the bear market that had hit almost all sectors, is around 7% from being erased from global stocks (seen in the chart below). Economic and financial data is painting a picture of recovery, albeit slow, but it is a vast improvement from where we stood less than a year ago.
The quick turnaround has caught many investment managers and strategists flat-footed. This has led many to revise their predictions and outlooks, and to chase the rally that they have missed, seen in the articles below (from Bloomberg to Business Times)
Hedge Funds 'Throwing In Towel' on Stocks as Rally Forces Unwind
‘We Were Wrong’: Morgan Stanley’s Wilson Offers Stocks Mea Culpa
After a Misjudged First Half, Strategists Face a Short Squeeze
Like Kahneman’s quote at the beginning of the article, the likely cause of paying more attention to pessimistic outlooks is partly evolutionary. Offering a gloomy outlook often sounds more thoughtful than being optimistic. Try it — go around with a cheery demeanour and tell everyone that today will be great with sunny skies, and that the day would end with nothing going wrong. You’re likely to be met with doubtful looks. But tell everyone that you have bad news to share, and everyone will flock to you like moths to a flame.
There is always so much bearish commentary and doomsayers in the investment community. The reason that they still have their jobs is that people are more interested in hearing theories and projections about how stocks are going to collapse, rather than listen to the ‘boring story’ of how stocks will go up over time, even though the latter is true majority of the time — after all stocks spend 70% of the time going up, otherwise investing will be a loser’s game (see chart below).
The predilection of investors to err on the side of pessimism has led to a slew of new products being launched in the market — products which offer some form of capital protection but at the same time allowing investors to participate in some of the equity returns. Below are a few examples:
BlackRock Looks to Offer 'Buffer ETFs' That Aim to Limit Investors' Losses
First ETF with 100% protection against losses launches in US
Capital guaranteed products are not new, long being the domain of private bank structured products. But the launch of these new ETFs are targeted at retail investors and will have the ability to be traded over the exchange. These products work by employing a protective collar — this is where
The ETF buys the underlying index (S&P 500 or another equity index)
Buys a put option to hedge downside risk on the index
and sells a call option (which caps the upside)
and enables the put option to be financed.
The ETF involves options with set expiration dates which are usually packaged in a product that is sold and not traded. However putting these into a daily traded vehicle, subject to the whims and emotions of day traders, hedge funds, and computer algorithms — it remains to be seen how well it works or whether it could contribute to problems in the financial system in the future. There is already concern about the illiquid holdings in ETFs and research by the European Systemic Risk Board highlighted the systemic risks that these products posed.
But is your pessimism rewarded if you invest in such products? The chart below shows the comparison of a simple S&P 500 ETF (in green) versus two buffered ETFs (in dark orange and red). The PAUG ETF (red) was meant to stop the first -15% of losses, whilst the UAUG ETF (orange) was meant to stop losses between -5% to -35%. You can see that the long term returns are obviously not as great as the pure buy-and-hold. In addition, both went down during the COVID-19 sell-off and the bear market of 2022. So if you were an investor in these products and contrary to your expectations both suffered losses, you could be feeling a little more than concerned.
So maybe there is no need to feel too gloomy about the future. There are many more things in life to concentrate and focus on, rather than get caught up about what could or could not happen. A good way on preventing emotions getting the better of you, is to ensure that you have an investment plan which guides your asset allocation, and segregates your investment portfolios into the goals which you want to achieve.
This way, whenever you feel nervous, you can always check back on the reason why you invested in the first place and to monitor whether your current investment performance is within acceptable boundaries. If you want to find out more about how the investment plan can help you invest better towards your goals, speak to us.
