“All happy families are alike; each unhappy family is unhappy in its own way.”
That’s how Leo Tolstoy begins his epic novel “Anna Karenina.” The line has been quoted over and over again, in movies and articles and other books. It even has its own Wikipedia entry: the Anna Karenina Principle. The idea is that to be happy, a family must be successful in a broad range of arenas: romantic attraction, child raising, religious conviction, money issues, extended family relationships, and so on. Problems in just one of these areas leads to unhappiness. So unhappy families can be that way because the kids are uncontrolled, or they have money problems or any number of other issues.
The Anna Karenina Principle has been used to explain animal domestication, adaptive systems, ethical reasoning, and statistical theories. If one element fails, the whole system can fail. Animals with demanding diets or that grow too slowly or are too ill-tempered or don’t breed well in captivity make poor farm animals. Ethical failure can come from self-dealing or malice or social pressure or disrespect, and so on. Many factors are necessary for success; one failure can lead to systemic failure.
Does this Principle apply to markets? Are bull markets alike, while bear markets are each bearish in its own way? Looking at the significant pullbacks of the last 30 years is instructive:
Source: S&P, Bloomberg
Is every downturn different? Apart from the dot-com meltdown and more recent pullback, seven of the last nine major declines have been led by the financial sector. Even the 2016 downturn, ascribed to a 75% decline in the price of oil from 2014 to 2016, was led by a downturn in banks and insurance companies. The concern was if they had significant exposure to the booming oil sector, their loans could turn sour and these leveraged institutions could see losses all the way from Texas to North Dakota. It didn’t turn out that way, but that’s what market participants worried about at the time.
Also, most of these downturns either began in July or ended in October. There’s an ebb and flow to the market. While the past can never predict the future, it can illustrate some of its underlying dynamics. Financial fault lines often become visible in late summer and early fall in because of historic monetary pressures associated with our agricultural past. The stock market crashes of 1907, 1929, 1987, and 2008 all happened in September and October, and these intensified market declines that were already in progress. That’s what prompted Mark Twain to quip that October is an especially dangerous month to invest. The other dangerous months are the other 11 months of the year!
Mark Twain. Photo: A.F. Bradley. Source: Wikimedia
Unhappy markets are similar, not different: the financial sector has leveraged exposure to industries and businesses across the country. Problems in the economy are magnified and multiplied, and market participants take note. But you can’t just stay away from bank stocks and improve your returns. Leverage works both ways. The broad market returned 7.7% per year for the last 30 years, but without the Financial sector, portfolios earned 1.5% less per year, or about 100% less over the past three decades.
The Anna Karenina Principle has its limitations. Happy families may all be alike, but unhappy markets are alike as well: the financial sector usually sniffs out potential problems. So keep your eye on the banks!
Douglas R. Tengdin, CFA
Charter Trust Company
“The Best Trust Company in New England”