Long-term investors embrace times like these
Whenever stock prices fall, you may expect to hear your advisers at Lorica Partners say something like:
“Time in the market beats timing the market”
“Be fearful when others are greedy, and be greedy when others are fearful”
We stand behind both statements for long-term investors – which is anyone who is hopeful of achieving financial freedom or wishes to fund their own post-working lifestyle.
But there are many other things that are true.
When prices fall, it is normally because investors have become more risk adverse, and uncertainty about the future has increased. Markets are highly efficient information processing machines – there are over $1 trillion of equity trades everyday pricing in information about the present and expectations for the future – but no one pretends they are 100% accurate all the time. But profiting from ‘mispricing’ is not easy.
Many stockbrokers contend when markets are volatile, they can deliver the most value by picking stocks that have been oversold. Unfortunately, there is no compelling evidence to support this.
One research paper we read looked at all US broker reports in March 2009 – which turned out to be the bottom of the market during the GFC[i]. They examined how successful the stock picks were two years later. Here are the results:
The stocks with the most ‘buy’ recommendations were up 73%, but this was below the market return of +88%. And the most unloved stocks? They were up +165%.
And even though the market always bounces back after prices fall, not all stocks necessarily bounce back.
For example, it is true when the dot.com bubble burst in the early years of the century, many stocks fell to attractive prices. Here are how 5 stocks performed when the bubble burst, and then over the following 19 years[ii]:
It certainly was a great time to buy when prices fell. $1,000 invested in Apple turned into $587,000.
However, not all stocks bounced back. Some stocks fall because they are, in fact, dying. Remember these names?
When investing, it is important to buy the market, not just a handful of stocks. The greater the concentration of stocks you hold, the greater the risk your share portfolio will underperform the market.
A new research paper[iii] shows that about 1 in 5 US listed stocks over the past 100 years survived and outperformed the market over a 20-year period.
And of the stocks that outperformed over the past 20 years, on average, only 30% of these stocks continued to outperform over the next 10 years:
It’s a reminder that jumping on winners is no guarantee of success. Whilst the FAANG stocks of Apple, Google, Amazon, Facebook, and Netflix collectively returned 28.02% pa from 2012 to 2021 – which was well above the Russell 300 Index return of 16.3% pa – their prices have sharply reversed in 2022, as this graph shows:
Some of these prices will bounce back, but some may not.
There is a big difference between speculation and investing. For long-term investors, now is a good time to buy a well-diversified portfolio of publicly listed stocks. Yes, stock prices may fall further, but somewhere in the future, people will reflect on June 2022 as having been a good time to get into the stockmarket.
The challenge for many investors – to either invest in the stockmarket or stay in the stockmarket – is to separate their emotions from investing. The graphic below reminds us that when prices are down, fear is commonly experienced, but the expected return of stocks increases:
Here is an article we wrote in 2019 to demonstrate the maths behind the expected return of stocks going up when prices fall: https://loricapartners.com.au/insights/2019/3/5/why-youre-crazy-to-sell-when-shares-prices-fall-njm9a
Stock market slides over a few days or months may lead investors to anticipate a down year. But a broad Australian market index had positive returns in 17 of the past 21 calendar years, despite some notable dips in many of those years. Even in 2020, when there were sharp market declines associated with the coronavirus pandemic, Australian stocks ended the year with gains of 2%.
Source: Dimensional Fund Advisors
Volatility is a normal part of investing. As the graphic above shows, in most years the stockmarket is down at least 10% at some time. Tumbles may be scary, but they shouldn’t be surprising. We expect them and plan for them.
As the table below shows, since 1928, there have been 54 occasions when the U.S S&P 500 index has fallen more than 10%.
Source: Why does the stock market go up over the long term? Ben Carlson, 3 May 2022
Almost half of these falls lasted less than 100 days. The longest fall was 929 days in the early part of this century, which coincided with the dot com crash and 9/11. The market fall during the GFC was quicker at 517 days, but the market fell further at -56.8%. But the market always bounced back. Over the entire time period, the S&P 500 has delivered an average annual return of 9.8%.
And returns over the last 5 years remain strong, even with recent volatility and the global pandemic. The S&P 500 index is up 70% over the past 5 years and the ASX300 Index up 26%.
In summary, the current market volatility, whilst unnerving for some, is par for the course when investing in stockmarkets. If you have access to sufficient cashflow to meet your expenditure requirements for at least 5 years, investing your surplus into a diversified share portfolio now is likely to prove a prudent long-term decision.
Author: Rick Walker
[i] Equity Analysts Prove Hazardous to Returns as Contrarian Stocks Rise 165%’, Matt Walcoff and Lynn Thomasson, Bloomberg, 10 January 2011.
[ii] https://www.youngmoney.co/p/price-anchoring-broken-stories
[iii] Singled out: Historical performance of individual stocks, Dimensional Fund Advisors, 11 May 2022