The stock market is always ripe for drama. In mid July, the markets were healthy, and most investors were pleased. Then, on August 8, there was a selloff. The Dow Jones Industrial Average had its sharpest one-day drop since the financial crisis of 2008—it fell 634.76 points or 5.5% that day. While the week ended with back-to-back advances for stocks, the markets entered a period of great volatility.
For a moment, I admit, I had my own twinge of concern. The U.S. has never had a credit rating less than AAA. So, this is new territory, and 2008 is still fresh in everybody’s minds.
But here’s the thing: You can act sensibly and do well in the stock market. Unfortunately, most investors fall short of the market’s overall performance, oftentimes because they panic. Notice this chart:
S&P 500 v. the Average Equity Investor
- Source: DALBAR 2011 Qualitative Analysis of Investor Behavior*
Here’s what we learn from this chart:
- Equity investors tend to buy stocks low and sell them high, otherwise they’d have performances closer to the S&P 500.
- The average equity investor barely beats inflation.
- Staying the course, rather than trading in and out of the markets, leads to better results.
Of course, it’s not possible to invest in the S&P 500 directly, and its performance does not reflect the expenses associated with the supervision of an actual portfolio. Still, for illustrative purposes, the chart makes the point that “staying the course” is better than trying to time the markets.
Here’s another chart: In the first quarter of 2009, the markets were declining. The Dow Jones Industrial Average reached bottom on March 9, 2009. But, of course, there was no way to have known that March 9 would be the bottom. If you had held on and stayed in the market, you would have minimized your losses. The Dow experienced a positive return period from March 10 to March 31:
Just 22 Days
- Source: Dow Jones Indexes*
What we learn from this chart:
- March 9, 2009, was the low closing for the Dow year-to-date.
- The Dow rose 5.8% the very next day, March 10.
- An investor who “held on” for 22 days gained 16.4% over that period.
- One bad quarter can be made much worse by panicking and selling early.
Once again, the Dow is just an index. The index is not available for direct investment, and its performance does not reflect the expenses associated with the supervision of an actual portfolio. Still, for illustrative purposes, the chart makes the point that “staying the course” beats trying to time the markets.
And what was true of the Dow in Q1 2009 was also true of the S&P 500, the Russel 2000 Index and the Nasdaq Composite Index. For example, an investor with Nasdaq holdings who panicked and sold stock on March 9, 2009, would have lost -19.3% that quarter, but only -2.7% had he held on for 22 more days.
BUFFETT AND ROTHENBERG
Let’s now turn to the time-tested wisdom of Warren Buffett and the professionals at American Funds.
Warren E. Buffett is widely regarded as one of the most successful investors in the world. The primary shareholder, Chairman and CEO of Berkshire Hathaway, Buffett said in a recent television interview with Charlie Rose that Monday, August 8, was a big stock-buying day at Berkshire Hathaway.
“I like buying on sale,” Buffett said. “[On Monday, August 8], we spent more money in the stock market buying than any day this year.”
James F. Rothenberg is Vice Chairman of Capital Research and Management Company, the investment adviser for American Funds. In a letter to investors, Rothenberg advocated the need for context.
“I know how hard that is, but I also know it’s crucial to long-term investing success,” he wrote. “For many investors, the context for today’s market is 2008. This is not 2008.”
Rothenberg says that despite the losses in the global equity markets on August 8, the conditions that exist today are far different from 2008.
“The major U.S. banks are in much better shape than they were when the housing market collapsed. Today economic growth is weak, but it is positive. In 2008 stock prices often seemed disconnected from economic reality. Today corporations are producing solid earnings even in a weak economy. As an investor, I find that reassuring.”
TWO MORE PERSPECTIVES
American Funds’ Guide to Market Recoveries sums up present (and past) markets very well.
“After significant declines, the markets have typically become unbearably rocky—causing investors to want to react to every bump along the way,” the Guide states. “Bearish headlines, troubling events and disappointing economic news fueled feelings of uncertainty. But while these times have been remembered as extraordinarily difficult, they also have been times of opportunity.”
The Guide goes on to show that investors who found the courage and conviction to stay the course were rewarded with attractive results.
American Funds’ The Long View (July 2011) further puts into perspective the “shocking and costly natural disaster in Japan, escalating unrest across the Middle East and North Africa, an oil price surge and Standard & Poor’s sending shock waves through Wall Street and Washington by lowering its outlook on U.S. federal debt.” The Long View provides charts, data and pictures to show how investment opportunities abound in places, such as Poland, India, Malaysia and South Korea to name a few. Look at Shanghai in 1990 and again 20 years later:
Shanghai – 1990 and 2010
- Source: The Long View (July 2011), American Funds, p. 7
In summary, then, consider a little perspective. Markets are going to forever soar and dive, and turn smiles into frowns—in the short-term. But in the long-term, I believe we have a lot to look forward to.
As always, call if you have questions.
Joe Bonnett, CFP®
402-556-8858
* The S&P data are provided by Standard & Poor’s Index Services Group. Dow Jones data provided by Dow Jones Indexes. Inflation data from Stocks, Bonds, Bills, and Inflation Yearbook(tm), Ibbotson Associates, Chicago (annually updated by Roger G. Ibbotson and Rex A. Sinquefield. Market indices are not available for direct investment. Past performance is not a guarantee of future results.
Market closings are based on published data. Bonnett Wealth Management is not responsible for publishing errors. Please consult a qualified advisor before making any investment decisions.
