The stock market has just completed its worst sevenweek period in 20 years, marking a loss every week. On May 20th, the S&P 500 entered into bear market territory before eking out a very modest gain on the day. Thus far, the S&P 500 has managed to remain in a correction (defined by a decline of 10-20% from the highest point), whereas both the NASDAQ Composite and Russell 2000 are immersed in bear markets. To date, the NASDAQ has fallen 27% from its peak close in November while the Russell 2000 has dropped 21%.During times like these, it is far better to ride out the storm rather than dumping stocks, which only reduces the opportunity to recover losses. Here are six considerations to help maintain perspective during turbulent times.
In 2020, the stock market went through the shortest bear market on record which lasted just five weeks. Yet, this bear market presaged the worst economic collapse ever in the economy as real GDP plummeted 31.7% in the second quarter of that year. Investors panicked during the early months of the pandemic and unloaded most of their equity holdings. The S&P 500 quickly declined 34% and touched bottom on March 23. By the end of June, the typical investor was only 12% invested in the equity portion of their portfolio. In the meantime, the stock market had shot up 39% off the bottom and by August, the stock market had fully recovered and was trading at an all-time high. Only 47% of investors were fully invested in stocks at this juncture. That means that most investors missed out on a major market move, acting counter to the age-old adage “Buy Low, Sell High“. Human emotions drive the stock market to extremes. During turbulent times, it is critical to take a long-term view when investing and do what is hardest during market downturns – nothing.
Most investors buy high and sell low: As detailed above, investors sold their equities after the decline and only 12% were invested after a major move off the bottom. Many still on the sidelines went on to miss a new all-time market high.
Study after study demonstrates that portfolio managers, even those that spend 50 hours or more each week at plying their trade, are incapable of predicting stock market direction and unable to shift assets propitiously between stocks and fixed income securities. The collective record of professional money managers in beating the stock market is dismal. According to the SPIVA report on some 2000 actively managed funds, only 10% have beaten the S&P 500 over the past 20 years.1 If the professionals encounter such great difficulty, after spending countless hours trying to do this, other investors are destined to be even less successful. As such, the best approach is to stay in stocks even when the headlines read at their worst. Mutual fund studies have shown that investors lose as much as 1.5 percentage points in performance every year because they buy and sell stock mutual funds at the wrong time.2
There is another rarely discussed pitfall in dumping stocks during market sell-offs. Selling securities with gains always should be done as a last resort because taxes have to be paid on these gains. Handing over part of your principal to the IRS in the form of taxes means that these dollars are forfeited to the IRS and can never be used again to create wealth. This reality is often ignored when one’s emotions are running rampant.
The S&P 500 peaked on January 3 of this year and was flirting near its all-time high by the end of January. Investors poured $21 billion into equity funds in January according to Refinitive Lipper.3 Thus far in May, with the market much lower than in January, about $14 billion has been yanked out of stock funds. Consider that if investors liked the stock market in January when the market was much higher, they should love it now, with stocks looking like they are on the bargain counter. The investment business is the only business in the world in that when the product goes on sale, the buyers head for the exits. It is always best to stay put in the face of steep market declines. However, investors in a positive cash flow situation have a rare opportunity to buy lower cost shares and average down. This is not easy to do, but it is the best thing to do in a panic-stricken market
The current bear market (for the NASDAQ and Russell indices) is unusual in one respect. It has occurred less than two years following the shortest bull market on record dating back to World War II. Historically, bull markets have lasted 60 months on average with an index gain of 160%. The 2020-2022 bull market falls short on both measurements, posting a relatively short 26-month run accompanied by an index gain of 114%. Although concerns about war, inflation, and rising interest rates currently dominate the headlines, there are reasons to believe that the underlying economy is still strong. Unemployment is at historically low levels and ISM data on the manufacturing and service sectors still indicate strong economic growth despite widespread pessimism. We do not see a recession on the horizon given current historically low interest rates which gives the Federal Reserve ample room to rachet up rates without inflicting major harm on economic growth.
Aggressive Growth funds represented the only asset class to outdistance inflation during the 1970’s when inflation rose from 3.3% in 1972 to 12.5% in 1980. Golden Eagle’s Investment Style Indexes show that aggressive growth funds gained 130% over eight years while the CPI advanced 95%.4No other asset class kept up with inflation during this period. Notwithstanding that inflation is currently running near double-digit rates, the underlying stocks in the Golden Eagle Strategy are producing profits growth of 134% on average. Thus, there is very sizable real profits growth being exhibited by these companies that should allow this strategy to stay well ahead of inflation in going forward. Surprisingly, the aggressive growth style has proven to be the most rewarding over the past half-century but is still underrepresented in most investment portfolios.
In closing, we continue to emphasize two essential points which investors should always keep in mind. First, bear markets are temporary, but the bull market is permanent. Second, selling stocks in a declining market does not reduce risk; all it does is to reduce the potential of recouping losses. Finally, stay strong and keep an even keel in the face of adversity. Take your vitamins. Get your exercise. And whatever you do, focus on the positive and resist the temptation to bail out of the market.
Sources: 1 SPIVA U.S. Year-End 2021 Scorecard (spglobal.com) 2The American College News Center 3Lipper US Fund Flows 4Investment Style Index sources: Wiesenberger Mutual Fund Report, Frank Russell Company, Golden Eagle Strategies.