Beware Of Grasping at the Shadow

Last month we highlighted the hilarious absurdity of making predictions about the market. Coming out of a negative year in 2022, it is perhaps no coincidence that the most comical (in hindsight) of those predictions were those rooted in recency bias and centered on the idea of continued negative performance in 2023. After another strong month of equity performance, it got us wondering where 2023’s performance stands in relation to history.

Should we be happy? Should we be worried? These are relevant questions we hope to answer, which we hope will provide valuable context for you.

Looking at past performance is of course potentially dangerous, but it can be useful to maintaining what the late Trevor Moawad called “neutral thinking” in his book, “It Takes What It Takes.”

For example, if I’m pessimistic or worried about the market or economy, it might be helpful to know that we are having the third best start in the S&P 500 Index in the last three decades.

Best Starts to the Year for the S&P 500

Source: GFD, SPDR S&P 500 ETF Trust (SPY), 2/1/1993 to 7/26/2023

The only two years better than 2023 are 1995 and 1997. The years right behind 2023 are 2019 and 2013. All four of those were very positive environments both from an economic and market standpoint.

If you look at the Nasdaq, it’s even more positive. In fact, 2023 is the best start for the index over the last 30 years, with 1995 being second.

Best Starts to the Year for the Nasdaq

Source: GFD, Nasdaq Composite (^IXIC), 1/1/1993 to 7/26/2023

If you’re a pessimist, the knowledge of how good this year has been might frighten you further because it could confirm a bias that things are overvalued. However the data, small though the sample might be, says otherwise. Of the top 10 best starts in the S&P 500 over the last 30 years, the average return from July to December is 9.4%, as the table above summarizes. The Nasdaq paints a similar picture. While there are a couple of negative finishes to the last five months sprinkled in, the average is more than 13%, and the median is more than 15%.

Now, lest we steer our emotional vehicle from one ditch of worry and fear to the other ditch of irrational optimism and risk-seeking, we must remember that we can’t make predictions about how the year will finish. The beauty of using a systematic investing process is that we don’t have to. Having a system allows us to simply be at peace with where we are, enjoying the fact that we are likely well-positioned for the given set of circumstances – but also feeling relatively assured that we will pivot if necessary.

Trend following often invites bias-based critiques from observers. Pessimists may question a seemingly-slow exit during a market drop, but stay silent when the trend reverses. Similarly, optimists may criticize our re-entry timing, yet remain content with positioning when the market is falling. Among those who don’t yet fully understand and embrace the potential value of trend following, there seems to be a prevailing feeling that our systematic investing process could put us in a difficult position from which it might seem impossible to recover the anticipated opportunity cost.

What the Monday morning quarterbacks fail to realize is something we determined in our research 20 years ago, validated during the subsequent two decades, and see yet again in 2023 thus far: The potential advantage of a trend following system is that, while it can be slow and take years to play out, if you stick with it you may end up in great spot relative to the alternates.