Happy New Year! Geez, are you all glad that 2018 is over? What a rough fourth quarter! It started quite harmlessly with Suze Orman poking fun at the FIRE movement. Not a big deal, we hit back and even had some fun with it. But the quarter ended with Mr. Market taking our stock portfolio to the woodshed. The S&P500 Total Return Index (dividends reinvested) was down 19.36% at some point (closing value Oct 3 to closing on Dec 24, total return). Not only was the fourth quarter brutal on your stock portfolio, but the FIRE movement has also become the target of continued ridicule. It looks like FIRE critics have come up with some cool and creative new acronyms:
- FIRE = Foolish Idealist Returns to Employer (MarketWatch)
- DIRE = Delay Inherit Retire Expire (Financial Samurai)
- And even I made up one, just for fun, see the title. Just to get everyone’s attention!
But how serious are the gloom and doom predictions? I posted two months ago why I’m not worried yet but that was before the precipitous drop in stocks. Has anything changed now? Readers have asked me that and I have asked myself what the recent equity plunge will do to the FIRE movement. So, that’s what I will do in today’s post. First, my take on the wild equity market moves and then why I think that this is obviously not the end of the FIRE movement.
Come on, the stock market wasn’t that bad!
Let’s look at the big picture. 2018 was a down year for the stock market as the S&P 500 lost about 4%, with dividends reinvested. Big deal, if you get your pants in a knot over that you probably shouldn’t invest in stocks in the first place. Keep in mind that 2018 marks the first annual loss in 10 years (!), see the table below. Nine years in a row, we saw gains between just above zero percent all the way to 30+%. And guess what? That run had to come to an end. It was about as predictable as anything can be!
But I grant you that: What’s more painful than the annual loss is the drawdown, i.e., the sharp drop between October 3 and December 24. But is that so unusual? The other sharp drawdowns comparable to the one in 2018, let’s say anything worse than 15%, occurred in 1990, 1998, 2000, 2001, 2002, 2003, 2008, 2009, 2010, 2011. Eleven occurrences in 31 calendar years. So, this was a “normal” loss you’d expect every three years, even outside a recession year.
Also, notice that when calculating the annual drawdowns from the previous peak, I reset that number every year on January 1. This underestimates the true drawdowns if the bear market stretches over multiple years (2001-2003, 2007-2009). Now the 2018 drawdown looks a bit more benign when compared to 2001-2003 (47% below all-time-high in 2002) and 2008-2009 (55% below all-time-high in 2009). To reach the 55.25% drop peak to trough as in 2007-2009 we’d still have another ~48% to go from the December 31 close. Oh my, let’s hope we won’t go there!
But there’s good news: Equity valuations look pretty attractive now!
Just for fun, because I have all the data at my fingertips, I included some valuation stats in the table as well:
- Quite amazingly, corporate earnings (4-quarters trailing) grew by a whopping 27% (!!!) in 2018 (based on Q4 estimate of just under $140 from S&P Dow Jones, as of 1/4/2019) over the year, compared to the average growth rate of just under 7% p.a. during that time. This is mostly due to the corporate tax cut that started on January 1, 2018. It’s quite rare for earnings to grow at a double-digit rate and the index to lose in the year. I’d argue that with earnings growth so strong and at least solid going forward there’s a good chance that drawdown in Q4 is only temporary.
- The PE ratio fell substantially because of this double whammy: P=numerator dropped and E=denominator increased. We’re now significantly below 20. In fact, today’s PE Ratio is now below both the median and mean for the 1988-2018 era. For full disclosure, we’re still above the all-time mean and median, though!
- Not surprisingly, the Shiller CAPE ratio fell to about 27 again from about 33 at its peak. Because the denominator is the average of 10 full years worth of earnings the drop wasn’t quite as dramatic as the simple PE ratio, so 27 still looks quite high in absolute terms. But keep in mind that some of the really low earnings numbers from 2009 will be rolled out, so the Shiller CAPE is bound to drop some more!
- A few other valuation measures: I always like to look at the earnings yield (simply the inverse of the PE ratio), and the earnings yield relative to the longer-term (10-year) Treasury bond yield and the short-term (3-month) T-bill rate. All three valuation measures look quite attractive again, especially the yield spreads are among the highest in the entire 30+ years. Anybody who feels the itch to throw in the towel and sell stocks should look at those yield spreads. What are you going to buy with the proceeds? Bonds at less than 3% yield?
So, what do I make out of this? It’s clearly not the end of the world when the stock market goes down occasionally. If the economy doesn’t completely tank (and the indicators I follow still look all right) my early retirement should be just OK. I pointed that out again in November and that assessment hasn’t changed yet.
So, here in the ERN household, we should be OK despite the equity volatility. We actually made decent money with our options trading strategy in the calendar year 2018 and even in the tumultuous fourth quarter. How about the FIRE community in general? That brings me to the next point!
Why the FIRE community will be just fine
Most members in the FIRE community will likely be just fine because they fall into (at least) one of the following categories:
- You’re not even retired yet! Most people in the FIRE community fall into that category. I did an informal survey in the ChooseFI Facebook Group and the overwhelming majority of FIRE fans there are more than 5 years away from retirement. My personal advice to them: If you’re still saving for retirement then a drop in the stock market is a lot less scary. Don’t listen to the naysayers! Keep contributing regularly to your equity portfolio so you can even make Dollar Cost Averaging (essentially Sequence Risk reversed) work in your favor. You’re picking up shares at discounted prices and by the time this current mini-bear-market blows over, you’ll be ready for a fun early retirement. And who knows, maybe at that time a 4% withdrawal rate is sustainable if equity valuations normalize again!
- Many FIRE bloggers retired many years before the equity market peak (Root of Good, Go Curry Cracker, etc.) and I’m sure they were smart enough not to ratchet up their withdrawals in response to their growing portfolio. Their withdrawals, even if adjusted for inflation, would have shrunk as a percentage of their portfolio when the market went from one all-time-high to another. Thus, even with the recent drop, they may just withdraw well below 4%. If you’re retired now and you withdraw less than 4% of your portfolio now, then relax, you will be just fine!!!
- Most of my blogging buddies who indeed retired at or close to the equity market peak in 2018 have very conservative withdrawal rates: yours truly, Fritz at The Retirement Manifesto, Tanja at Our Next Life, just to name a few. If your withdrawal rate is low enough that your portfolio would have made it even through the Great Depression (e.g., closer to 3% rather than the often quoted 4%) then there’s a pretty good chance that you’ll make it through this garden-variety mini-bear-market. I doubt anyone I know who started with their withdrawal rates at around 3% would have reached an effective WR of 4% by now. But even 4% looks pretty safe now considering that we have pretty attractive, close to the median, equity valuations again!
- Many established FIRE bloggers bring in sizable income from their blog and other businesses. I don’t mean to shame anyone (I’m not the retirement police) but just to point out the obvious. As much as folks like the MarketWatch writer Shawn Langlois hope the FIRE community will quietly go away (or blow up with a bang and a tearful apology video???), let’s just all agree that this will be is very unlikely.
- If you don’t invest heavily in equities you don’t feel the pinch from the recent pullback. Some FIRE bloggers specialize in real estate (Chad Carson, Paula Pant and others) and they will likely not feel the pinch of lower equity prices. Their blogs may even gain more traction when folks disenchanted with the equity volatility will start looking for alternatives. A caveat, of course, is that if this market pullback were to become a full-blown recession (which I doubt) then even real estate investors will feel the pinch: property prices will drop and even the cash flow may come under pressure when more renters become delinquent.
- Many FIRE bloggers have working spouses and don’t have to rely (much) on withdrawals from their portfolio. That reduces or even completely eliminates Sequence Risk.
But not everyone will be OK
I don’t want to be accused of the false dilemma fallacy. Just because calls for the “obliteration” of the FIRE community (Shawn Langlois’ words, not mine) are premature, it doesn’t mean that every single FIRE enthusiasts will have a pleasant early retirement experience. You will likely have a very rough ride if one or more of these apply to you:
- You retired in your early 30s at the peak of the 2018 market and applied a 4% withdrawal rate. Maybe you were impatient and thought that 22x or even 20x annual expenses is close enough. Well, if you keep that withdrawal amount you’re now withdrawing closer to 5% maybe even 6%. A quick look at my Google SWR sheet reveals that a 5% SWR has a 30+% chance of running out of money over a long horizon (60 years). With a 6% rate, we’re looking at 50+%. Good luck with that!
- You previously retired with a 4% SWR but you made the mistake of ratcheting up your withdrawals. Of course, you could simply “ratchet back” your consumption if the bull market comes to an end. Most people in the FIRE community should be able to do so. But keep in mind that in the past, one would have tightened the belt for years, even decades, as I pointed out in my “flexibility posts” in the SWR Series (see Part 24 and Part 25).
- You fell for some of the other not so prudent advice out there on the internet: simply “diversify” with small-cap value stocks and you increase your SWR by another 0.5 percentage points? The only problem: the value/small-cap outperformance hasn’t worked for quite a while. It certainly did between 1926 and the mid-2000s. But just when everyone heard about the small-cap and value “premium” is when it was apparently arbitraged away. More recently, small-caps and small-cap value stocks mostly underperformed the broader index funds: VTSAX for the total stock market VFIAX for the S&P 500 (large cap, which I use as the benchmark for my Safe Withdrawal Rate Series). Large-cap value (VVIAX) did slightly better during Q4, but small-caps (VSMAX) and small-cap value have had a pretty bad run, both over the longer horizons and especially during 2018 and Q4. How about diversification with international stocks? They took a bath in 2018 as well, even more so than the small-cap value fund, though the drawdown in Q4 wasn’t quite as bad. So, the lesson here is that there is no magical trick to squeeze out more out of your safe withdrawal rate by just picking the “right” equity style. If you listen to some of the nonsense out there in the personal finance world and think that miraculously affords you a higher SWR, don’t be surprised if doesn’t work as planned!
Over the last few years, the FIRE movement had its spot in the news. Even the ERN family was featured on CNBC.com in October. But with the increased visibility comes more scrutiny and we should welcome that scrutiny as an opportunity to kick the tires and test our assumptions. I don’t see a serious threat to my personal retirement (yet) and the calls for the end of the FIRE movement are likely premature as well. Most early retirees who were prudent with their safe withdrawal rate will likely do well. And if you’re not yet retired, keep saving and keep Dollar-Cost-Averaging through this market drop and you’ll do just fine!