Perkins outlook: Beware the true ‘plunge’



A running joke here involves the use – and recent misuse – of the word ‘plunge’. Breathless headlines such as “Stocks plunge, end day 1.4% lower!” strike us as amusing. Since when does ‘plunge’ indicate a relatively minor loss in the financial lexicon? We have invested through so much turbulence and so many wild swings over the years and have come to understand ‘plunge’ as appropriate for larger declines of 20%, 30% or even more.

Perhaps it is a sign of the times, in this case the great bull market we are enjoying. After all, language does evolve. As Professor Anne Curzan of the University of Michigan notes in her TEDx talk “What makes a word ‘real’?” English is a living language, with a constant flux of new words emerging, and others dropping out. A word’s meaning can even change quite radically. She gives the example of ‘peruse’, which at one time meant careful reading or examination but now more commonly suggests a mere skimming of material. Complacency is ‘in’, so to speak. As markets have not declined very much lately, it is understandable why ‘plunge’ is being used for any move downward, no matter how small.

Rolling returns vs trailing returns

However, we might want to wait a bit longer before modifying our dictionaries. Given the intense focus on recent performance among many of today’s participants in financial markets, the three- and five-year trailing results are enjoying particular prominence. Viewed through this point-in-time perspective, many broad stock indices and investment accounts currently have glittering performance, no doubt leaving many investors feeling flush. But is it really this easy? And what, if anything, do those historical results suggest about what lies ahead?

Consider instead a rolling three- and five-year perspective to gain a better sense of the investing experience over time (see chart 1). This view shows that steep drawdowns are part of the journey and can dramatically alter portfolio returns for the worse when they occur. True market plunges can take shiny historical returns into deeply negative territory, where they can stay for extended periods.

Chart 1: Steep drawdowns are part of the journey

Source: Bloomberg, daily data from 1 July 1999 to 31 July 2018. Shows the rolling cumulative total return for stocks in the MSCI World Index as a percentage. Rolling returns are calculated by assessing performance over a series of three, five or ten-year blocks, rather than from one specific date.

Many investors have neither the wealth nor the temperament to endure steep or long-lasting declines in their portfolios. Significant losses are difficult to recoup, as future gains compound off a lower level of capital and an investor will rarely enjoy the benefit of a new stream of income to aid in the recovery effort. Moreover, it is psychologically challenging to stay the course or – better yet – add to holdings when markets and portfolios are experiencing turbulence. While the early and late 2000s were good times for deploying capital into the stock market, doing so was uncomfortable. Remaining invested required significant discipline. Casually allowing ‘plunge’ to be redefined as a modest move down is naively forgetful of this history and of market dynamics in general, and we believe this temptation to forget about risk in investing should be avoided at all costs.

Adding resilience to an investment portfolio

Defending gains realised during the great bull market will require a resilient portfolio, in our view. This begins at the individual stock level, by specifically asking the question “What could go wrong?” in addition to considering the brighter scenarios. We believe companies that are not overly economically sensitive, with revenues that are highly diversified by customer and repeat purchases, are worth interest. Our analysts are identifying attractively valued stocks of this type across consumer staples, large-cap healthcare and select ‘industrial staples’ holdings. We are also intrigued by ‘off-the-beaten-path’ companies that are not as well known in the investment community and are, therefore, perhaps not as richly valued or vulnerable to drawdowns as more mainstream stocks.

Resilience is also a crucial consideration at the portfolio level. Given the radical easy monetary policy that central banks around the world deployed in the wake of the Global Financial Crisis, it is perhaps to be expected that the bull market has been broad in nature. Monetary policy is a blunt tool. This suggests to us the converse may also be true: risk derived from generous, but likely temporary, financial conditions permeates the global stock market. Therefore, in addition to buying carefully vetted individual stocks with conviction, we think investors should emphasise variety in their portfolios. Reducing correlations across holdings will be an important risk-mitigating feature when market turbulence returns, in our view.

Our thoughts on the changing financial lexicon are more anecdotal than scientific, to be sure. Still, investment cycles have their tops and it may prove beneficial to consider the indicators, even those of a subjective nature. In our experience, investors who defend their gains well in the next down cycle will by extension be better positioned to outperform over the full cycle vis-à-vis those who lag in a sell-off.

These are the views of the author at the time of publication and may differ from the views of other individuals/teams at Janus Henderson Investors. Any sectors, indices, funds and securities mentioned within this article do not constitute or form any part of any offer or solicitation to buy or sell them. Past performance is not a guide to future performance. The value of an investment and the income from it can fall as well as rise and you may not get back the amount originally invested. The information presented does not qualify as investment advice or a recommendation. For promotional purposes.


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