History tends to repeat itself. The economy and the stock market are no different. We have had, and will continue to have, economic expansions followed by recessions. To give you an idea of what to expect, consider the last recession.
It was the result of another bubble bursting (in Silicon Valley, not housing). In 2 1/2 years (early 2000 through late 2002) the S&P 500 fell by 50.5%. Investors felt massive pain and many took dramatic action by getting out of the market. That was the right emotional decision in their minds at the time (because they didn't want to take any more pain), but it backfired financially.
After a 2 1/2 year bear market, the S&P 500 bottomed in October 2002 and rose by 105.1% over the next 5 years. Those investors who stuck with the market and even added to their investments as prices dropped reaped huge rewards. Those who exited the market out of fear missed out.
With the market down more than 35% in the last year, what should investors do now? For the answer, all we need to do is look at history. About 97% of all five year periods have seen the stock market go up, as have nearly 100% of all 10-year periods. If you are a long term investor (5 year time horizon or more by my standards) the numbers imply you should stay in the market.
You may have noticed that Warren Buffett has been very active in the market in recent weeks, investing billions of dollars. Is he crazy? No, he simply knows that when prices drop significantly there are bargains to be had. Future stock price returns are going to be higher during bear markets than bull markets because prices are lower. It isn't any different from buying a house, a car, or a cart of groceries. When things go on sale, we should buy more of them. Have you ever been to the store, seen your favorite cereal on sale, and bought a couple extra boxes than normal because of the price? I know I have.
Stock investing shouldn't be any different than grocery buying. It is true that it all sounds so simple, but isn't because emotions and psychology come into play more with stocks. Warren Buffett has the perfect temperament for the market, so he can step in and buy when everyone else is selling. His famous quote is "be greedy when others are fearful and fearful when others are greedy" and he is acting on that principle through all of this.
It is not an easy thing to do, though. Most people want to get out of stocks right now, not sit tight or buy more. That is what their emotions are telling them to do. Unfortunately, it is not the right decision to make for an investor who has the time to wait things out for several years.
I will conclude with a story. During the first week of October 2002 I wrote a letter and sent it out to about three dozen friends and family members. I explained that the stock market was very depressed but that there were tremendous investment opportunities out there. I made the case that allocating money with Peridot Capital at that time would likely prove very profitable over the coming years.
Guess how many people invested new money with me? None. The responses were predictable, although I had hoped some would take me up on my offer. Many recipients simply ignored the letter completely. Some responded by telling me that they had sworn off the market after they had lost so much. One declined my offer by explaining "As you know, this is not the easiest environment to lure potential investors." Very true, but ironically, it was the perfect time to do so.
A week after I sent out that letter, the S&P 500 index bottomed out at 768.63 on October 10, 2002. Over the next five years the market more than doubled and reached an all-time high of 1,576.09 on October 11, 2007.
So my bear market advice in as few words as possible would be:
1) If you have a 5-10 year investment time horizon, or longer, do not sell your stocks simply because prices have fallen significantly and it is scary to watch the daily market swings and read the dire news headlines.
2) If you have the financial means, and are comfortable doing so, adding to your investments during times like these will most likely prove very profitable as long as you can take a long term view on the investment.
3) Don't pay attention to the daily market volatility and headlines if you don't have to. If you are investing for 5 or 10 years, who cares what the market does today, this week, or this month? It's irrelevant. Warren Buffett often says that he wouldn't care if the market shut down for a few years and reopened because he is confident in the long term prospects of the stocks he owns.
If only we could make that happen in times like these. It would ease the short term pain and also ensure long term gain.
History Lesson and Bear Market Advice 14 comments
October 10, 2008
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This article has 14 comments:
As long as the companies he 'bought' don't go under he will make out with 10% on his money (where can you find those yields anywhere else?) and if the company's stock rebounds he will also make additional billions on top of the 10%.
To compare Buffett's buying to Joe Sixpack's buying is comparing apples and oranges. Buffett can't lose.
Second: Note that the Nasdaq has yet to reclaim it's 2001 high over 5000. You would need to more than triple your money from today's levels to "get even" for purchases made during that time frame. Given today's economy a market triple in the next 5 years is unlikely.
And finally: it took over 20 years to "get even" from the highs in 1929. The only reasonable parallel for today's banking crisis is the onset of the Great Depression. What is happening in the economy today is 1987 overdosed on steroids and turning into the incredible Hulk. Expect it to require a lot more time to recover than it did in 1987.
It's not always sunshine and lolipops. Just because buy and hold has worked in every 5 year period for the last 20 years doesn't mean it always works. Sometimes discretion is the better part of valor and keeping what you've got is the best choice available.
Disclosure: I went to cash in November of 2007 and am patiently waiting for signs of a market recovery to put my money back to work.
1. Index investors with 25 years or longer investment time horizons.
2. Careful value investors who do rigorous research to find the solid companies that will do well and grow over periods of 5-10 years.
3. Traders. The 1930s had many primary market cycles (more than 1/3 of all the primary bull and bear market cycles of the past 107+ years).
If the economists (and pundits) are wrong about the seriousness of the current credit crisis, comparisons to the 1930's are not important.
How many investors think they know what the future scenario is? Not many, I believe, based on the record volatility in the market.
Buffett is in another league, he has the cash to make special deals the likes of us will never be able to negotiate. Cash keeps coming into Berkshire every day and he can wait out any financial crises. What Buffett does is not relevant to what we should do-enough!
You can be forgiven because it has been economic "reality" for thirty years.
But there are many ways of looking at economic matters and we might be forced to look at some of them soon.
Outside buying and selling, there are such things as politics, religion, sociology, economic classes, history and even anthropology.
A message to academic economists: Mathematics is a lovely thing to behold but it is not all of reality.
Jump out of your academic fish bowls and behold the world!