08/09/2024
Let's talk about properly flying through stock market turbulence. I frequently have clients that make decisions about stocks based on the wrong criteria.
Now, these things matter deeply to them and usually have to do with their outlook on the future of our country. Because of that, they come up often during election years, especially presidential election years.
These concerns get magnified, not just during election years but even more so when the stock market is declining. Both sides make the mistake, but I think conservatives more so, of thinking that these concerns are of interest to the stock market and conclude the stock market may not be the place to be. It can become a genuine but misplaced panic when it comes to stock market investing.
Actually, the stock market cares very little about these things, and how those issues go rarely has anything to do with how the market does over the next four years.
What Drives the Market
I have made this speech countless times, but it is worth a reminder now. The stock market cares about four things - future profits, future dividend payments, certainty, and stock prices. It especially cares about changes in the outlook for these and it cares when prices get extreme.
The stock market also cares about what affects these four things, and these are things like interest rates, economic growth, new technologies, the labor market, corporate taxes, and inflation.
What Does Not Drive the Market
The stock market does not care about politics unless they influence the above. Morality, the character of candidates, federal spending and debt, border control, diversity, mass shootings, gun control, war in the Middle East, income inequality, and changes to these have almost zero effect on stock prices.
Changing Risk Tolerances
I have also noticed that people’s risk tolerance varies a lot with how things are going with stocks. The same person that says they are a 7 of 10 for risk tolerance when stocks are going up is liable to say they are a 4 of 10 when the stock market is going down. That’s why determining a person’s true risk tolerance is the most difficult part of my job. I tend to give more weight to how they feel when stocks are dropping because that’s when it really matters but I can only do that when that is happening. And doing so means having less in stocks when the market is doing well and that doesn’t always meet expectations. Inexperienced investors expect that I should be able to time the market and don’t realize how difficult that is to do.
Timing the Market
When people want to sell their stocks as markets drop or add more to their stock allocation when they are comfortable this is called short-term market timing. Study after study has shown that this rarely works well because it means that people are selling when the market is getting cheaper and buying as it gets more expensive. This is not a recipe for success.
Even if the charts show that the stock market is far above its long-term moving average, that only means there will be a downturn sometime, it doesn’t tell you when. I have seen markets very far above their long-term moving average for as much as 18 months and rack up another 30% in gains before stalling out.
Bear Markets vs. Corrections
I have been generally, though not completely successful in navigating true bear markets, but that is a certain type of downturn.
A bear market is defined as a general decline in stocks of more than 20% while a correction is a drop of 10-20%. Bear markets take time to unfold and don’t usually start with sharp drops. They usually accelerate after a slow start, often last at least a year or two and may drop 50% or more.
In my 40-year career, there have seen only four bear markets – 1987, 2000-2002, 2008-2009, and 2020. I saw the first two coming and sold stocks in advance. The third I did not, nor did hardly anyone, and I sold when stocks were down about 20% and stayed in cash until they were down 50%. The last was due to COVID, totally unexpected, lasted a very short time and I did not sell.
Corrections of 10-20% are much more difficult to spot coming. Corrections are generally much scarier at first, with sharp drops in a short time. Think of them like extreme turbulence on an airline flight. It may feel like the plane may break apart or head for the ground nose first, but that is not how it ends up.
Corrections are not the time to sell out. You will almost always be late rather than early and the ride back up is usually as short as the ride down. You will experience most of the drop and little of the rise.
Steady as She Goes
Over my career, my own experience has matched the studies that show the more a portfolio turns over the lower the return. It’s not selling costs that lower returns. Aside from taxes, those are close to zero these days, it is being wrong more often than right, late to sell and late to buy. Think of it as an airline flight again. The more time I spend zigzagging to avoid storms, the later I am going to land and the lower my average speed. However, it is a good idea to avoid flying through hurricanes.
I think that gives a pretty good picture of my philosophy.
Sum it Up
My advice right now is to ignore the news when it comes to stock market investing. Remember that most troubling news does not affect the stock market and even the news that does should not be used to being going in and out of stocks. Let me tell you if I see big trouble ahead that is worth avoiding. It will not be because of politics or the crazy, stupid things that go on in Washington, it will likely be because of extreme excesses in the market, and while we are in the process of correcting one of those at the moment, I don’t see it turning into a bear market. If I change my mind on that, I will let you know.
