How to Navigate Current Stock Market Volatility Revisited
On May 6, I shared my thoughts on how to navigate the current stock market turmoil, noting that the selloff was likely driven by many different investor concerns: inflation, interest rates, war in Ukraine, supply chain disruptions and an economic slowdown in China. Unfortunately, with these factors still in play, the stock market (using the S&P 500 as a benchmark) has since fallen about another 11%. We have officially entered a bear market, defined as a decline of 20% or more from the previous peak.
Amid the daily parade of scary headlines, no one knows what will cause stocks to rally from here. But through all this uncertainty, I keep in mind Warren Buffett’s observation that “the future is never clear; you pay a very high price in the stock market for a happy consensus. Uncertainty is actually the long-term value buyer’s friend. As I wrote on May 6, I wholeheartedly agree with this sentiment:
The short term will likely be bumpy, but I’m optimistic about the future. In fact, now is the time investors should consider increasing their exposure to equities: historically, the best time to invest is when you feel the worst. Even very experienced and successful investors find it difficult to take this step, especially when prices continue to fall, but buying big companies at discounted prices and holding them for the long term is historically how the best returns are earned.
Although bear markets can be painful, they should not cause investors to sell. Decade after decade, investors have been best served by holding their positions in high-quality companies, and they’ve been even better served if they have the funds (and the stomach) to buy more – after all, the timing of Market bounces are nothing if not unpredictable. As the following chart shows, since 1957 the median market return (again, measured against the S&P 500) has been positive 1 month, 3 months, 6 months, and 1 year after the official entry into bear territory. Admittedly, in some years stocks have fallen during these periods, but that has been the exception, not the rule.
I continue to believe that investors need to stay the course. I have not reduced my equity exposure and have no intention of doing so; Instead, I like to take advantage of these times of market dislocation to increase my equity exposure. I’m sorry to lose money for my clients, but I consider this year’s losses so far to be “losses on paper”, not a permanent loss of capital. After all, the price of a stock on any given day is simply what people are willing to pay for a company. at this moment. But I believe that in the long run, either the stock market will reflect the true value of the company or an acquirer will buy it at fair value. I have no reason to believe that this time it will be any different.
Unfortunately, today’s stock prices are driven by panic over macro headlines, not underlying company fundamentals. Wall Street has historically overreacted to economic data, whether positive or negative, prompting economist Paul Samuelson to observe that “the stock market has predicted nine of the last five economic recessions.” The stock market hates uncertainty more than anything else, and right now we’re knee deep in it. How long before finding solid ground is anyone’s guess.
Reasons for optimism
But the situation is not entirely gloomy. The U.S. banking system hasn’t been this strong in decades, unemployment is at historic lows, and consumer balance sheets have been strengthened by recent government stimulus programs (although the savings rate has recently fallen and that credit card balances have increased significantly – developments I will be watching closely). A recession is certainly possible, but these factors should help to mitigate its effects.
Equally important, investor sentiment is at multi-year lows, with consumer confidence even weaker than after the 9/11 attacks, during the 2008-2009 financial crisis and during the coronavirus shutdowns. These two markers have always been great counter-indicators of future stock market returns. Consumer confidence may well decline from there, but it’s worth noting that – according to JP Morgan, the average 12-month return for the S&P 500 after the eight lows in consumer confidence since 1971 was 24.9%:
Finally, and most importantly, the stocks I own are fairly inexpensive, and the best predictor of future stock market returns is valuation. At times like these, it’s essential to put things in their proper perspective. Today’s headlines are alarming, but they pale in comparison to those we saw in 2008-2009, when people thought the global financial system was on the brink of collapse. Likewise, in 2020, when the coronavirus brought the economy down in just a few months, investors feared for their physical health, not just their financial health. Even so, staying the course was the right decision either way, and I see no reason why this time should be any different.
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