Kurt Vonnegut
Having experienced a multitude of market crises, I realize that history never repeats itself exactly, so I’d be arrogant not to admit that almost anything can happen from here. It is a distinct possibility that things will get worse before they get better in the stock market. Even if the economy holds up, fear and pessimism could cause of investors to panic and send the market down further than justified by long-term economic fundamentals.
At times like this, it is essential to have a sense of perspective and rely on sound long-term investment disciplines when making decisions. It is important to avoid panicking because of short-term market concerns and uncertainty. It is easy to put too much weight on negative scenarios when all you hear is bad. Inevitably, investors always flee the stock market at just the most inopportune moment, when the tremendous bargain basement deals are obtainable. I love the chart above because it shows how the average equity investor underperforms the markets. He has only earned 4.5% per year over the last twenty years due to emotional trading. Over the same 20 year period, the S&P 500 domestic stock index earned 11.9% per year and the bond market earned 7.9%. The average equity investor missed out on these returns by fleeing the market at the low and re-entering when it has already recovered. Dalbar Inc. calculated the average investor’s performance using net aggregate mutual fund sales, redemptions and exchanges by month for twenty years.
Bubbles lead investors to make errors in judgment, thereby mispricing assets on the way up. Investors do not understand the risks they are taking and what could happen. On the flip side, riskier assets often fall to bargain prices on the way down when investors are frightened. The risks become clear: investors panic when losses start to accumulate and flee the market. This pattern of overzealousness-followed-by-panic repeats throughout the history of mankind.
While the perspective gained from years of experience is useful, humbleness is just as important. It is crucial to always be open to market signals and stay intellectually honest about factors you can and cannot assess. Or else you will miss when the market is warning you that it isn’t the normal boom-bust cycle but a full scale melt down. I spend hours assessing risk, global economies and investment markets. I try to communicate what I have learned to you through my blog, newsletters, phone calls and meetings. At this point, this is a normal bear market. Fleeing the markets now would be a big mistake since stocks are priced to outperform bonds over the next five-years. Second, big market downturns invariably present opportunities - you just have to have conviction.
Since 1946, there have been nine bear market declines of 20% or more. The average drop was 32.5% over 14 months. The average bull-run lasted 70 months, with average returns over 185%. While this does not guarantee future results, it certainly provides food for thought. With major indices down about 20% from their October 2007 peaks, it would not be surprising to see the markets fall another 10%, at least from the perspective of history. Many traders are now referring to 2008 as the Year of Capitulation.
It has been a tough first half, and even some legendary money managers have taken a hit. GuruFocus.com follows the trades of legendary money managers and keeps track of their results over 6-month and 12- month time periods. If you think your portfolios performance has been dismal, you may take some consolation in seeing how many Managers of the Year and other top-notch investors have been (Marty Whitman down 43%). Even Warren Buffett is now in negative territory for both the 6 and 12-month periods just ended. Warren has a great perspective on market down turns. He said at his recent shareholder meeting, “If a stock [I own] goes down 50%, I’d look forward to it. In fact, I would offer you a significant sum of money if you could give me the opportunity for all my stocks to go down 50% over the next month.” Mr. Buffett wants the price to decline so he can buy more cheaply. I wouldn't bet against any of these guys rebounding in a big way once the market picks up in the future.
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