For some context, I will begin by offering a brief history of stock market declines:
- The S & P 500 has had intra-year declines of 14% (known as a correction), on average, every year since WWII
A decline of about twice that amount (30%, on average) – known as a bear market — has occurred one year in five or six
- Since 1926, the probability of any loss in a 12 month period is only 25%; the probability of a loss > 10% is 13.2%; the probability of a loss >20% is 6.1%; and the probability of a loss >30% is 3.1%
- The S & P 500 has gained 10.1% annually for the past 50 years (1968-2017) despite having experienced 7 bear markets that declined at least 20% each!
- We cannot say when or at what market level corrections will begin or end (nobody can)!
- What history has shown us is that however deep or shallow the correction, it has always been temporary. Historically, following these corrections, the permanent increase in the values and dividends of the great companies of America and the World (i.e., S & P 500) have rebounded and gone on to establish new highs in both values and dividends.
- As J.P. Morgan said, “bear markets represent the period of time whereby equities are returned to their rightful owners.”
After sitting out one of the longest and strongest bull markets in a generation (and fearing and loathing it), the American investor returned to the markets with a vengeance in January with record weekly inflows into equity funds ($30 billion for the week ended January 24th) and close to $100 billion for the month. This follows an eight year period where US investors were net sellers all through the market’s increase! It’s no surprise then, that the market which manages to skunk the greatest number of “investors” that it can, no doubt aided in some shares being returned to their rightful owners.
Nobody loves these declines more than the financial media who accurately, but disingenuously, reported that the Dow’s 1,175 point decline is the worst point decline in history. The trouble is that the point decline is historically meaningless unless compared to the base against which it declined (i.e., the level of the Dow). As an example, the date that still holds the “real” record for the worst one-day decline in history (by far) is “Black” Monday, October 19, 1987. The Dow fell 508 points (less than half the total point decline this Monday). However, the Dow was 2,246 before the 508 point decline. So, the percentage decline was 23! Monday’s percentage decline was 4.5 (hardly a record)!
So, what we’ve experienced so far this year is an 8% move from a recent high (remember that a correction is a 10% move off of a high and the average intra year correction since WWII is 14%). So far, 2018 has seen a plain vanilla – less than average – intra year decline. Moreover, the Dow – up 24.5 % in 2017 – began 2018 at 24,824. At the close of business of the worst one day point drop in the history of the world, the index stands at 24,345 (down 2% year-to-date).
During these times the media will have any number of nameless “gurus” being asked unanswerable questions like: is this move a buying opportunity or do we go lower? TUNE THEM OUT AT ALL COSTS! Their job is to sell advertising, encourage more clicks on their website, etc…Their capacity to help investors is the only thing that is less than their interest in doing so.
How To Succeed As An Investor During Corrections and Bear Markets
Remember that bear markets of at least 20% (occurring once every 5 or 6 years) and corrections of at least 10% (every year) are the rule rather than the exception. Expect them and have a plan to take advantage of them (i.e., rebalancing bond money into sale priced equities and higher dividends). Remember the only declines we have ever experienced in a diversified quality equity portfolio (i.e., S & P 500) have been temporary! In every case when a decline has ended, the permanent increase of equity prices and dividends has reasserted itself and equity prices and dividends have gone on to new highs. The benefit of being able to ride out the declines (with some empathetic coaching from your advisor) is wealth that has historically compounded at about seven full percentage points over inflation and at more than twice the real compound return of high quality bonds. The challenge to successful equity investing, therefore, is not intellectual or analytical, but temperamental. If one can’t ride out a 14% annual market decline and a 30% decline one year in six, one can’t be an equity investor. Remember that the only thing less meaningful than these market declines is the causal relationships that the media attempts to ascribe to each movement!
The Opportunities Ahead
In our view, the single most important and powerful global trend shaping the future of the global economy is the developing global middle class. Each and every month, millions of people are crossing the poverty line (in countries like India, Vietnam, China, Indonesia, Mexico, Thailand, etc.) into the middle class. According to a recent Brookings Institute study, the global middle class accounted for $35 trillion in spending in 2015 (about 1/3 of the global economy)! Brookings estimates that middle class spending may reach $65 trillion by 2030. They also estimate that within a couple of years, for the first time in history, the majority of the world’s population will live in rich or middle class households. As an example of the power of this trend, GM, who in 2004, sold one car in China for every ten in the US is now selling at a rate of one for one and fewer than 30% of the Chinese have driver’s licenses. For these reasons and others which we are happy to discuss (some of which are outlined in my June 2017 essay entitled “Why the market can’t go up”) it is our belief that we are still in the relatively early stages of a powerful long-term uptrend.
As investors, we tend to be much more concerned with movements in the level of our assets than with the overall level of our assets themselves. As a result, we often adopt short-term “strategies” (i.e., market timing) that lead to the diminution of long-term wealth. Peter Lynch is famous for saying that “far more money has been lost by investors preparing for corrections or trying to anticipate corrections than has been lost in corrections themselves.”
We must identify goals and develop plans to meet our goals. Only then should portfolios be built using investments whose historical returns would have enabled goal attainment in the time allotted. A portfolio without a plan is a speculation. In our experience, all successful investments are goal focused and planning driven, while all failed investments are market focused and performance driven.
Stay calm and invest rationally.
Warren Buffett’s mentor, Benjamin Graham, said many years ago, “Individuals who can’t master their emotions are ill-suited to profit from the investment process”