How Investors Should Prepare for a Decade of Directionless Markets

I bet if you took a poll of average investors, 90% would have a view on the market.

Investors often feel compelled to have an opinion on market direction. And the choices tend to be constrained to either up or down.

But what if the markets remain directionless over the next five or even ten years?

Passive investing won’t help. Not with conventional products anyway.

Because outside of up or down, there’s always a third choice when it comes to market direction that most people rarely choose – nowhere.

As of the end of the third quarter this year, the S&P 500 has done nothing over the last 24 months. It’s perfectly flat.

That’s two years of the market’s bulls and bears telling each other off… and all were proven wrong.

The last time the market did nothing over a rolling 24-month period was back in July 2008. 

That’s a long stretch of time. Investors have been groomed to think that markets simply rise with no end.

That’s not exactly wrong. Just the force of inflation alone guarantees a rise. That’s why cutting out the rate of inflation from the market return is the key to really understanding how things are.

The following is a performance table of the S&P 500 by decade, with the corresponding average rate of inflation:

When you look back at the post-war period in the market, there have been many stretches – decades long in some instances – where the market would barely move. And returns were abysmal when factoring in inflation. But you couldn’t tell simply by looking at the chart above.

When you factor in the average rate of inflation, you can see how it’s either feast or famine depending on what era you live in.

This means the 8-9% average annual market return that investors keep penciling in is an illusion.

After all, averages hide a lot of information. For 30 of the last 70 years, the market averaged just 2.6%. For the other 40 years, it was 13.8%.

So to get that expected market return, you’d better find yourself living in the right era.

Right now, the market is in a correction. It has fallen -10.8% from its year-to-date highs to the recent lows. So far, it’s merely a correction.

But we will see bear markets over the next few years and possibly some bull markets too. Markets moving up or down 20% is a high-probability bet.

That’s especially true in an inflationary environment that could turn into stagflation pretty soon. (Remember, stagflation is a stagnant economic environment alongside high inflation.)

In periods like the 2000s – and further back from the 1960s to early 1980s – the market experienced churning action several times before ultimately going nowhere. 

So in this environment, our return needs to exceed the “cost” of inflation and taxes. Factoring in inflation alone, the market’s real return is closer to 5.5%.

And based on the performance of the market over the last 24 months, the 2020s may be heading in the direction of famine.

We’re already seeing it… The return on the S&P 500 Index has been essentially zero over that time frame. Inflation has averaged 6.5% during that stretch.

Your 401(k) may be intact, but your buying power is not.

So the question investors need to answer right now is how they’ll make money if the market gets stuck for the next few years.

The answer is twofold:

1. You need non-conventional products.

2. You have to learn how to trade a range.

The second one may be out of reach for many unless you have lots of time to dedicate to it. But the first one is the reason Larry created The 2/20 Report.

This year, we have used a product you may have never heard of to combat the kind of market environment we’re in. They’re called structured notes – a hybrid fixed-income security that combines elements of both bonds and options. We’ve bought several notes paying 10-12.5% this year.

A plain vanilla note will pay you that high yield as long as the underlying index it’s linked to (like the S&P 500) doesn’t close down some percentage (like 30%) from the date of issuance. Anything above that and your principal is protected.

And even if it does close below it, the principal you invested will match the loss on the index. That means – when you factor in the coupon payments you’ve received – either way you look at it, you are beating the market.

Investors need products that can make money whether the market is rising, falling, or loudly doing nothing, like it is right now.

Structured notes can make money in all three.

Regards,

Eric Shamilov
Analyst, Trading With Larry Benedict