As of this writing, in June 2022, we are in a bear market, as the S&P 500 has declined more than the 20% arbitrarily defined as proof of a bear. Proximate causes of the decline are well-documented: pandemic-related disruptions to global supply chains that inflate the costs of goods and services to consumers and reduce corporate profit margins; the war in Ukraine that has fomented record energy prices, curtailed grain exports, and sent fertilizer costs skyrocketing which will continue to pressure global crop prices; the Federal Reserve’s inflation-fighting campaign of raising interest rates that will, by design, cool economic growth, and hopefully, tame inflation to a targeted and growth-friendly level. So, what now for the individual staring at 20%, 30%, or higher paper losses on their investments? Sell, hold…or buy?!
Ask yourself three questions: (1) Do I believe the world will survive its current crises? (2) Do I believe the U.S. capitalist, market-based system of supplying goods and services to the consumer is still the best structure for generating wealth and prosperity, i.e., will the markets recover? and (3) Do I have more than enough cash and/or income to pay my living expenses for the next one or two years? If the answer to (1) is “No”, then it’s canned beans, camouflage, and candle time. You’re done reading. Start tunneling. If the answer to (2) is “No”, hit “Sell All at Market” on your brokerage account screen (or tell your broker to do the same); at least you’ll minimize trading costs on your way out. Again, you’re done reading here, but do tell me how you’re getting on in life, as I may have missed a better way. If you’ve made it to this point, then let’s explore question (3).
Warren Buffett famously stated: “…be fearful when others are greedy and greedy when others are fearful.” The current market turmoil reflects growing fear, although we are yet to see panic-driven indiscriminate selling of all stocks in a final capitulation that signals a bottom. That being said, no one can predict or spot an exact bottom, or a market top, and that is not the objective. The best investing strategy is to always have some cash “dry powder” and a list of great companies you’d love to own, or own more of, at a discount to their current stock prices. When fear permeates the markets, as it does every so often, price volatility increases, and even solid businesses with long, bright futures may suddenly be offered at significant, often irrational, discounts, as panicked investors head for the exits. For those more comfortable owning market indices instead of individual stocks, a general market downturn provides the opportunity to “average down” the cost of buying index funds. The point is not to sell if one does not need to, but rather to see these moments as opportunities to buy future economic growth cheaply. Experience, and an abiding belief in (2) above, point to greater wealth if one is generally invested in the market for the long term and prepared to withstand a few down years.
Using data from NYU’s Stern School of Business[1] on the returns for the S&P 500, including dividends, from 1928 through 2021, we find that, for all 5-year and 10-year rolling periods, the S&P 500 produced positive returns of 88% and 94% of the time, respectively. The Great Depression accounts for most of the negative periods. Over its entire history, the S&P has returned a compounded 10% while from 1972, the return was 11.1%, making the S&P 500 superior to bonds and real estate, the other major financial asset classes. If we begin the analysis just two years later, in 1930, and use rolling 12-year periods as the metric, then we find no negative returns at all. Therefore, while stock prices can be volatile from one year to the next, over longer terms, the continual growth of the U.S. economy outweighs any periodic shocks to the market, and patient investors will very likely grow their wealth by owning shares in Corporate America and increasing their ownership in times of stress. Embrace the bear!
[1] https://www.stern.nyu.edu/~adamodar/pc/datasets/histretSP.xls