It’s February of 2016 and the stock market has rallied over 250% off the 2008 lows in an almost uninterrupted bull market. But some cracks appeared to be showing. China was looking wobbly and the market had flash crashed a few times. Emerging markets were down 30%+ from their highs. Oil had cratered from $110+ to under $30 in 18 months. Industrials and manufacturing sectors in the USA appeared to be in a legitimate recession. And interest rates were still hovering at 0% on the overnight rate and 1.75% on the 10 year treasury.
It was a pretty scary couple of months at times and I repeatedly wrote that the environment reminded me a lot of 1998. That is, the cost of getting scared out of stocks in the short-term was a huge risk, but the longer-term risk of being too exposed to stocks was also high.
With the stock market near its highs and interest rates so low the average investor was confronted with a real problem – the stock market looks super risky, but the bond market has limited upside. And cash is earning 0%. In other words, this was an environment that was about to test a lot of people’s investment behavior. What was an investor to do?
There weren’t a lot of great answers at the time. So the smart investor just said “screw it, I’ll own both stocks and bonds and avoid the guesswork because they both look risky and I don’t know which one will actually end up being riskier”. The investor who owned an even split of 50% stocks and 50% bonds generated a 10% annualized return over the next few years. That’s 1.5% per year from the bonds and 18.5% per year from the stocks.
Now, we can’t rely on 18.5% per year from the stock market, but there are a bunch of useful lessons in here: