Anyone who has doubted the Federal Reserve’s resolve to get the credit markets and the economy moving again need only read today’s statement to become a believer. While some will question how quickly these efforts will jumpstart the economy, there should be little doubt that they will eventually bear fruit. The Fed’s moves today were stimulated by ongoing tightness in the credit markets, economic weakness, job losses and falling home and stock prices.
As expected, the Fed left short-term interest rates at historic lows near 0%. What was unexpected, however, and which galvanized both the stock and bond markets today, was their announcement that they would buy up to $300 billion of longer-term US Treasuries, and more than double their purchases of mortgage-backed securities up to $1.45 trillion. This “quantitative easing,” which the Fed last employed in the 1940’s, is designed to lower long-term interest rates, particularly mortgage rates. The Bank of England recently began a similar program with their own government bonds, and have succeeded in lowering long-term rates in the UK by 0.75%.
So we know from the Fed’s last foray into quantitative easing, and today’s experience in the UK, that it can work, and work quickly. In the 1940’s, the Fed targeted a 10-year yield of 2.5%, and these rates never went above that level for a decade. They were able to do so by holding only about 7% of outstanding Treasury notes and bonds, which today would amount to about $280 billion. So despite what some economists are saying, $300 billion should be sufficient, at least initially, to keep rates down. And today’s market reaction supports that: 10-year Treasury yields plummeted from 2.95% to 2.53%, the biggest 1-day drop in 47 years. Although the Fed has not stated a target interest rate, 2.5% seems to be what the market is betting on.
Lower long-term Treasury rates will translate into lower borrowing costs across the board, from corporations to municipalities to individuals. Even the US government will save money on interest expense. Lower rates, provided borrowers can obtain credit in the first place (a problem which other Fed and Treasury programs are targeting), provide an obvious benefit to the economy.
But the Fed did not stop there. It is simultaneously buying up to $1.45 trillion in mortgage-backed securities, in an attempt to further lower mortgage rates relative to other long-term debt. This represents about 12% of all outstanding mortgage debt in the US, and over 25% of debt guaranteed by Fannie and Freddie. I think there’s little question that taking this much debt off the market will substantially lower mortgage rates, and I suspect that 4% mortgages will become relatively common within the next few months.
Those of you contemplating a home purchase or refinancing should therefore wait a bit until making the plunge. I’ll be keeping a close eye on mortgage rates as well, and will let you know when I think they have bottomed. Note that in the past, the Fed was able to keep interest rates low for more than 10-years; thus I don’t expect rates to rise much until the economy is clearly on the mend.
The path to recovery will not be smooth, and there will be more pain and bad news to come. The current stock market rally, while it may continue for some time and potentially be very powerful, will undoubtedly be interrupted by some scary drops. And although March 9 may have set the final lows for this bear market, it is possible that they will be revisited or even violated somewhat before the new bull market is finally underway.
Fortunately, in addition to the Fed’s obvious resolve, there have been indications that the rate of financial and economic decline may be abating, which would likely precede a definitive turn upward. Housing starts were better than expected, as were retail sales. Commodity prices are rising (copper is up 22% in the past 30 days, oil up 31%). Oracle’s earnings came out better than anticipated, and they instituted a dividend for the first time (in contrast to many other companies that are reducing or eliminating theirs).
But perhaps most significantly, mergers and acquisitions (M&A) are seriously heating up. In the past few days alone, we’ve had several multi-billion dollar acquisition announcements: Pfizer buying Wyeth, Roche buying the rest of Genentech, and today, IBM buying Sun Computer. Big corporations have many $billions in cash looking for a higher-return home, and credit is again flowing to investment-grade companies. Many companies are selling at prices not seen for decades, and cash-rich firms are increasingly deciding that it’s safe to jump into the M&A fray.
Expect many more deals over the coming months and years. And keep in mind that much of the bull market of the 1980’s was driven by merger activity, at a time when companies had less cash and interest rates were far higher. Paradoxically, it is possible we will see a higher stock market in the face of a prolonged recession as stronger companies gobble up weaker ones. It will be fascinating to see how all this plays out; we certainly do live in interesting, if painful, times.
In future emails, I will expand further on how the Federal Reserve’s actions are likely to stimulate the economy. And I will give some detail on how I plan to position portfolios going forward, given all that’s happened and is likely to happen. We are clearly at an inflection point in economic history, one that will be written about for decades. It’s obviously crucial to prepare for the future based on the best information and reasoning one can muster, even if, in the end, the future is unknowable.
Wednesday, March 18, 2009
Monday, March 16, 2009
Can we trust the rally?
In the past few days, global stock markets have rallied about +10% from decade-plus lows. Today, the US market was again in rally mode, only to lose steam during the infamous final hour to close slightly down. The question on investors’ minds is, “Is this rally for real?” Will we see a significant rise in stock prices from here, or is this just another brief respite before yet lower lows?
It’s obviously too early to tell, but several signs suggest that this rally may have “legs.” Even if it is a countertrend rally rather than the first of a new bull market, it may last for a while and generate a welcome partial recovery in stock prices. My reasons for thinking this are several:
1. Volume has been higher recently on up moves than on down moves.
2. The number of stocks hitting new lows was declining even as the major averages took out their October and November bottoms.
3. The bulk of sellers recently appear to be individuals (“dumb” money) rather than hedge funds and institutions (“smart” money).
4. A lot of news lately has been better than expected:
• Several big banks announced that they’re actually making money so far this year.
• GE’s downgrade was less than expected and the company now has a stable credit outlook.
• Retail sales were higher than expected.
• Home sales were up in California.
Calling the end of this grueling bear market is still premature, but we’re overdue for a significant rally. Hopefully we’re in it now.
And regardless of the short term picture, the longer-term outlook for stocks remains bright. Sometime soon we will set generational lows for stock prices that we may never see again. Perhaps we already established these lows last week at an S&P 500 of 666 (a good omen?). Wherever and whenever that elusive bottom comes, we will look back on it years from now as an historic long-term opportunity that most people will have missed out of short-term fear.
It’s obviously too early to tell, but several signs suggest that this rally may have “legs.” Even if it is a countertrend rally rather than the first of a new bull market, it may last for a while and generate a welcome partial recovery in stock prices. My reasons for thinking this are several:
1. Volume has been higher recently on up moves than on down moves.
2. The number of stocks hitting new lows was declining even as the major averages took out their October and November bottoms.
3. The bulk of sellers recently appear to be individuals (“dumb” money) rather than hedge funds and institutions (“smart” money).
4. A lot of news lately has been better than expected:
• Several big banks announced that they’re actually making money so far this year.
• GE’s downgrade was less than expected and the company now has a stable credit outlook.
• Retail sales were higher than expected.
• Home sales were up in California.
Calling the end of this grueling bear market is still premature, but we’re overdue for a significant rally. Hopefully we’re in it now.
And regardless of the short term picture, the longer-term outlook for stocks remains bright. Sometime soon we will set generational lows for stock prices that we may never see again. Perhaps we already established these lows last week at an S&P 500 of 666 (a good omen?). Wherever and whenever that elusive bottom comes, we will look back on it years from now as an historic long-term opportunity that most people will have missed out of short-term fear.
Thursday, March 12, 2009
Are stocks cheap yet?
Today the stock market showed us that it is capable of going up as well as down, rising over +6%, which is obviously a nice change. Now we have to see if it can put in a few up days in a row, which it has had trouble doing for most of this year.
The impetus for today’s big jump seemed to come from Citigroup, of all places. Their CEO said that they’ve been profitable for the first 2 months of 2009, and that they expect this quarter to be their best since Q3-2007. If even Citigroup can make money in this environment, maybe the banking sector is finally on the mend after receiving $billions in bailout funds. Time will tell.
Whatever the reason for today’s move, it seems that the market “wants” to go up, as evidenced by several recent days that started with strong gains, only to be pared or turned into a loss during the final hour. In the fall, much of that final hour selling came from hedge funds; this year, it has been mostly individuals liquidating their mutual fund holdings. At some point, buyers will overwhelm sellers for more than one day, and the market will start to recover. Maybe today was the beginning of a longer trend; maybe not. We’ll know soon enough.
Regardless of what happens over the next few weeks or months, we need to feel confident that stocks really are cheap enough to buy. My last email talked about the long-term trend of stock returns and how far below trend we’ve recently fallen. As stocks gradually return to trend, they should provide above-average returns. Today, I’ll talk about stock valuations, looking at whether or not stocks today are historically cheap. I’ll do this by comparing today’s valuations with those during two major buying opportunities of the past century: 1982 and 1932.
The attached article contains the long version for those who want all the details. The Reader’s Digest version is below:
I wrote the article in part to respond to a New York Times piece entitled “Why Stocks Still Aren’t Cheap,” published on February 20, when the S&P 500 was nearly 10% higher than today. It proposed that because the 10-year average price-earnings (P/E) ratio of the S&P 500 was 14.5, below average but still well above the lows of 6 to 7 reached in 1932 and 1982, stock prices still had a ways to fall. I went on to point out the flaws in the author’s approach, and to do my own comparison of stock valuations today compared with those two prior periods.
I identified 4 shortcomings in the authors analysis: 1) 10-year periods, while they do smooth out the highs and lows of corporate earnings, are arbitrary; 2) the author didn’t account for inflation; 3) the proper or “justified” P/E ratio varies at different points in time owing to changes in interest rates, required return on stocks, payout ratios and expected earnings growth rates; and 4) accounting rules have recently changed, making comparisons with prior period earnings somewhat problematic.
To address these problems, I did the following: 1) calculated 5-, 10- and 20-year average P/E ratios at each time period (2009, 1982 and 1932) and averaged those; 2) adjusted earnings and prices for inflation; 3) calculated justified P/E ratios for each period based on interest rates and other data from the respective time period; 4) added an adjustment for recent accounting changes. I found that the last of these made little difference, so I eliminated it from the comparison.
The results indicated that stocks at 2009’s low for the S&P 500 were undervalued by about 12%, compared with a 14% undervaluation in 1932 and a 29% overvaluation in 1982. This analysis suggests that stocks today are compelling values, in line with the great buying opportunities of the past century.
I then went on to use several other valuation methods to compare stocks today with 1982 and 1932: price/sales (P/S) ratio, price/book value (P/B), price to replacement value (P/Q) and residual value. In all 4 cases, the actual measure today was below the justified measure, while in 1982 and 1932, at least one of these measures was higher than the justified value. The conclusion again was that stock valuations today compare very favorably with 1982 and 1932.
Lastly, I looked at 1974, which was a bear market bottom that did not precede a decade-plus bull market (the 1982 bear market was still to come). Valuations at that time appear to have been even lower than today, 1982 or 1932. Warren Buffett was a big buyer at that time; his superior results suggest that, if you buy stocks cheaply enough, you can make good money even if another major bear market will soon follow.
My conclusions were as follows: Putting all of these valuation measures together, we find that stocks today appear about as cheap as they did during two of the great buying opportunities of the past century, 1982 and 1932 (although perhaps not quite as cheap as in 1974). This doesn’t mean they can’t go lower still over the next few weeks or months. But their historically low valuations, based on my analysis of market history over the past 138 years, suggests that stocks should provide returns far above their historical average over the next 10 to 30 years.
I know I can’t time the bottom, but stock returns’ current distance below their trend line, plus the extremely low valuations suggested by my analysis, make me comfortable that buying stocks (or continuing to hold them) around these prices will eventually prove to be a very lucrative move.
The impetus for today’s big jump seemed to come from Citigroup, of all places. Their CEO said that they’ve been profitable for the first 2 months of 2009, and that they expect this quarter to be their best since Q3-2007. If even Citigroup can make money in this environment, maybe the banking sector is finally on the mend after receiving $billions in bailout funds. Time will tell.
Whatever the reason for today’s move, it seems that the market “wants” to go up, as evidenced by several recent days that started with strong gains, only to be pared or turned into a loss during the final hour. In the fall, much of that final hour selling came from hedge funds; this year, it has been mostly individuals liquidating their mutual fund holdings. At some point, buyers will overwhelm sellers for more than one day, and the market will start to recover. Maybe today was the beginning of a longer trend; maybe not. We’ll know soon enough.
Regardless of what happens over the next few weeks or months, we need to feel confident that stocks really are cheap enough to buy. My last email talked about the long-term trend of stock returns and how far below trend we’ve recently fallen. As stocks gradually return to trend, they should provide above-average returns. Today, I’ll talk about stock valuations, looking at whether or not stocks today are historically cheap. I’ll do this by comparing today’s valuations with those during two major buying opportunities of the past century: 1982 and 1932.
The attached article contains the long version for those who want all the details. The Reader’s Digest version is below:
I wrote the article in part to respond to a New York Times piece entitled “Why Stocks Still Aren’t Cheap,” published on February 20, when the S&P 500 was nearly 10% higher than today. It proposed that because the 10-year average price-earnings (P/E) ratio of the S&P 500 was 14.5, below average but still well above the lows of 6 to 7 reached in 1932 and 1982, stock prices still had a ways to fall. I went on to point out the flaws in the author’s approach, and to do my own comparison of stock valuations today compared with those two prior periods.
I identified 4 shortcomings in the authors analysis: 1) 10-year periods, while they do smooth out the highs and lows of corporate earnings, are arbitrary; 2) the author didn’t account for inflation; 3) the proper or “justified” P/E ratio varies at different points in time owing to changes in interest rates, required return on stocks, payout ratios and expected earnings growth rates; and 4) accounting rules have recently changed, making comparisons with prior period earnings somewhat problematic.
To address these problems, I did the following: 1) calculated 5-, 10- and 20-year average P/E ratios at each time period (2009, 1982 and 1932) and averaged those; 2) adjusted earnings and prices for inflation; 3) calculated justified P/E ratios for each period based on interest rates and other data from the respective time period; 4) added an adjustment for recent accounting changes. I found that the last of these made little difference, so I eliminated it from the comparison.
The results indicated that stocks at 2009’s low for the S&P 500 were undervalued by about 12%, compared with a 14% undervaluation in 1932 and a 29% overvaluation in 1982. This analysis suggests that stocks today are compelling values, in line with the great buying opportunities of the past century.
I then went on to use several other valuation methods to compare stocks today with 1982 and 1932: price/sales (P/S) ratio, price/book value (P/B), price to replacement value (P/Q) and residual value. In all 4 cases, the actual measure today was below the justified measure, while in 1982 and 1932, at least one of these measures was higher than the justified value. The conclusion again was that stock valuations today compare very favorably with 1982 and 1932.
Lastly, I looked at 1974, which was a bear market bottom that did not precede a decade-plus bull market (the 1982 bear market was still to come). Valuations at that time appear to have been even lower than today, 1982 or 1932. Warren Buffett was a big buyer at that time; his superior results suggest that, if you buy stocks cheaply enough, you can make good money even if another major bear market will soon follow.
My conclusions were as follows: Putting all of these valuation measures together, we find that stocks today appear about as cheap as they did during two of the great buying opportunities of the past century, 1982 and 1932 (although perhaps not quite as cheap as in 1974). This doesn’t mean they can’t go lower still over the next few weeks or months. But their historically low valuations, based on my analysis of market history over the past 138 years, suggests that stocks should provide returns far above their historical average over the next 10 to 30 years.
I know I can’t time the bottom, but stock returns’ current distance below their trend line, plus the extremely low valuations suggested by my analysis, make me comfortable that buying stocks (or continuing to hold them) around these prices will eventually prove to be a very lucrative move.
Tuesday, March 10, 2009
It's lonely at the bottom
Now that the major global market indices are all near or below their November lows, we’re hearing the pundits predicting ever lower market bottoms. Calls for “Dow 5,000” have become common, and there was even an article in today’s Wall St. Journal talking about this possibility. Jim Cramer, the chair-throwing investment guru on CNBC, did his own calculation and estimated that a “worst-case scenario” could bring the Dow down to 5320 (got to admire his precision).
Obviously, all of these numbers are total guesses, as there’s just no way to know where the market will go in the near term. But investors continue to sell nonetheless, concerned that stocks may still be far away from a bottom. The bulk of these sellers during the current downturn, as opposed to last fall, appear to be individual investors, who redeemed $71.2 billion from mutual funds in the 4 weeks ended March 4. While this is down from the record $137.9 billion withdrawn last October, it represents an historically huge number and a marked increase from December and January.
Meanwhile, institutional investors, including hedge funds, have dramatically curtailed their selling of equities since the fall. And many institutions and professional investors are buying stocks. Warren Buffett, the wealthiest man in the world (earned entirely through a lifetime of investing) went “all-in” to stocks with his personal fortune last October, and has been putting Berkshire Hathaway’s huge cash hoard to work recently. Peter Lynch, legendary manager of the Magellan Fund during its heyday, remains fully invested in equities. Marty Whitman of Third Avenue Value Fund is buying the deep value stocks that he loves (and that have been getting especially creamed recently). Even George Soros, one of the granddaddies of hedge fund management who publicly remains quite negative, has been seen recently buying $billions in stocks for his Quantum Fund.
All the the investors mentioned above have stellar track records going back 30 years or more. Why would these people, and others like them, be buying, while the general public is selling? Do they know something the average investor does not? History tells us that they do, as the bottom of every prior bear market has been accompanied by heavy individual selling, while insiders and pros start buying or at least stand pat. I know that this one will be no different, but knowing this does not help me identify the date or the level of the market’s bottom.
At the risk of wasting my time and yours, I will take my own stab at where the bottom of this bear might be. Although many analysts have tried to use valuations to do so, bear markets at this stage are driven primarily by sentiment (i.e., fear) and the need (or desire) for cash, not by a cold analysis of stocks’ value. Valuation analysis is, however, useful in determining whether one is at a propitious long-term entry point; we will examine this in a subsequent email.
One might, however, be able to look at prior bear markets to get an idea of where the bottom might be. At its current level, the Dow Jones Industrial average is 13.8% below its low of the previous bear market in 2002. It turns out there have been only 2 prior bear markets in the past 120 years when this has happened, that a bear market low is below the level set in the previous bear market: 1974 and 1932. In 1974, after that brutal 2-year bear market, the Dow was 8.5% below the price reached at the bottom of the bear market in 1970. At the market’s historic bottom in 1932, the Dow was 35% below the low reached in the prior bear market in 1921.
Using this particular metric, the Dow could bottom during the current bear market anywhere between 4,935 and 6,628. The index is now slightly below the higher number. So on a very simplistic level, if you think things now are about as bad as they were during the darkest days of the 1970’s, then the bottom should be right around here. If you think the economy will get as bad as it did during the Great Depression, then we’re talking about another 24.6% drop. Or maybe somewhere in between.
But the above analysis is actually severely lacking in at least one respect, as it looks at price only, and does not take dividends or inflation into account. Including both of these factors, and going beyond the Dow to the more inclusive S&P 500 index, the US stock market actually returned 57.6% from June 1921 until June 1932 (11 years). This is obviously very different from a –35% drop. In the 4.3 years from June 1970 to October 1974, stocks actually lost –22.8%, showing the effects of high and rising inflation. Today, on this basis, stocks have returned –16.9% since October 2002. Using this approach, then, it seems that the worst-case bottom should be another 7.1% below today’s close.
In reality, the numbers above are just guesses as well, and not supported by financial theory. But it’s interesting that very different approaches yield a fairly narrow range of results. Either the bottom is right around where we are, or it’s between 7% and 24% lower. Either way, with the S&P 500 already –57.1% below its 2007 high, the lion’s share of the drop certainly seems to be behind us.
I don’t know whether the above is encouraging or discouraging. But either way, it’s really the wrong question to ask (after all that, you say!). The near-term market bottom is not only unknowable, it’s irrelevant to a long-term investor (at least from a rational point of view; emotions are an entirely different thing). What counts is where stocks will be in 5, 10, 20, even 30 years. That’s because stocks are a long-term investment by definition. Even an 85-year-old couple has a joint life expectancy of over 10 years, and a 65-year-old retired couple could easily see one spouse live for over 30 years. So don’t say you’re too old to look that far into the future.
So let’s look into the future by looking at the past. Review the graph below, which shows total return after inflation for the S&P 500 from 1871 through today. (Don’t worry about reading the dates.)
The squiggly blue line is the actual return from stocks, while the straight black one is a trend line that shows the average return over a period of nearly 140 years, including the recent bear market. Note that while actual stock returns have strayed both above and below the trend line at various times, they never stray that far before “reverting to the mean.” The greatest drops below the line were in 1920 and 1932. Stock returns remained moderately below the line from 1974 to 1987, as well as for most of the period from 1932 until 1954. But the reversion to the mean during these periods resulted in some fabulous bull markets.
Note where we are today: about the same distance below the line as we were in 1982. Unlike 1982, it took only months, not years, to get there. In 2000, we were well above the line, but the 2000–2003 bear market took us back to trend. The current bear market started with stocks only a little above trend, far less so than in 2000, the 1960’s or 1929.
Could we go further below the line, either in the short term or sometime down the road? Of course we could, and there’s no way to know. But the more important point is that sometime in the next decade or so, we should get back to trend, and possibly rise above it again, at least temporarily. This would result in abnormally high returns for stocks during that period.
To get an idea of what that future return might actually be, I extended the trend line for 13 years past June 2008, when the market most recently dipped below trend. I used 13 years because that’s how long it took the market to recover to trend after first falling below it at the end of 1973. If the market recovers more quickly that that, returns will be higher; if more slowly, returns would be lower.
The trend line return, by the way, is +6.61% per year (remember, this is after inflation). Real purchasing power doubles in about 11 years at this rate. Now, if we return to trend from here over the next 12 1/4 years, that implies an average annual return, after inflation, of +12.23%. At this rate, real purchasing power doubles in less than 7 years; after 12 1/4 years, your purchasing power would have increased over 4 times.
Could such an optimistic scenario come true? We obviously won’t know for sure until more than 12 years have passed. But total real returns of this magnitude are not out of line with prior bear market bottoms: comparable period returns were +12.31% after 1932, and +9.72% after 1974. As you can see, inflation was a great drag on returns during the latter period, even though during and after the Depression it took much longer (22 years vs. 13) for stock returns to revert to trend.
Although I don’t know for sure whether +12.23% will be close to the actual return experienced over the next decade or so, I am sure that the path will be anything but smooth. There will be great rallies and bull markets, as well as scary corrections and probably at least one bear market during this period. But the overall trend should be decisively up, and at a rate that is both historically high and better than most other investments (cash, bonds, commodities, real estate, etc.). The price one pays for this higher rate of return is more volatility, which on rare occasions reaches the crisis proportions we see today. But no crisis lasts forever.
One other thing I know by looking at the graph above is that the bear market of 2007–2009 will go down in history alongside the great bear market of 1929–1932 as one of the 2 worst ones in US history. We’ve had other severe bear markets, but none as sharp and brisk (or as scary) as these two. But a further examination of the graph might give one hope: the sharpest bear markets have historically been followed by the strongest rallies. This one should, too. Now if only I knew exactly when it will start!
Obviously, all of these numbers are total guesses, as there’s just no way to know where the market will go in the near term. But investors continue to sell nonetheless, concerned that stocks may still be far away from a bottom. The bulk of these sellers during the current downturn, as opposed to last fall, appear to be individual investors, who redeemed $71.2 billion from mutual funds in the 4 weeks ended March 4. While this is down from the record $137.9 billion withdrawn last October, it represents an historically huge number and a marked increase from December and January.
Meanwhile, institutional investors, including hedge funds, have dramatically curtailed their selling of equities since the fall. And many institutions and professional investors are buying stocks. Warren Buffett, the wealthiest man in the world (earned entirely through a lifetime of investing) went “all-in” to stocks with his personal fortune last October, and has been putting Berkshire Hathaway’s huge cash hoard to work recently. Peter Lynch, legendary manager of the Magellan Fund during its heyday, remains fully invested in equities. Marty Whitman of Third Avenue Value Fund is buying the deep value stocks that he loves (and that have been getting especially creamed recently). Even George Soros, one of the granddaddies of hedge fund management who publicly remains quite negative, has been seen recently buying $billions in stocks for his Quantum Fund.
All the the investors mentioned above have stellar track records going back 30 years or more. Why would these people, and others like them, be buying, while the general public is selling? Do they know something the average investor does not? History tells us that they do, as the bottom of every prior bear market has been accompanied by heavy individual selling, while insiders and pros start buying or at least stand pat. I know that this one will be no different, but knowing this does not help me identify the date or the level of the market’s bottom.
At the risk of wasting my time and yours, I will take my own stab at where the bottom of this bear might be. Although many analysts have tried to use valuations to do so, bear markets at this stage are driven primarily by sentiment (i.e., fear) and the need (or desire) for cash, not by a cold analysis of stocks’ value. Valuation analysis is, however, useful in determining whether one is at a propitious long-term entry point; we will examine this in a subsequent email.
One might, however, be able to look at prior bear markets to get an idea of where the bottom might be. At its current level, the Dow Jones Industrial average is 13.8% below its low of the previous bear market in 2002. It turns out there have been only 2 prior bear markets in the past 120 years when this has happened, that a bear market low is below the level set in the previous bear market: 1974 and 1932. In 1974, after that brutal 2-year bear market, the Dow was 8.5% below the price reached at the bottom of the bear market in 1970. At the market’s historic bottom in 1932, the Dow was 35% below the low reached in the prior bear market in 1921.
Using this particular metric, the Dow could bottom during the current bear market anywhere between 4,935 and 6,628. The index is now slightly below the higher number. So on a very simplistic level, if you think things now are about as bad as they were during the darkest days of the 1970’s, then the bottom should be right around here. If you think the economy will get as bad as it did during the Great Depression, then we’re talking about another 24.6% drop. Or maybe somewhere in between.
But the above analysis is actually severely lacking in at least one respect, as it looks at price only, and does not take dividends or inflation into account. Including both of these factors, and going beyond the Dow to the more inclusive S&P 500 index, the US stock market actually returned 57.6% from June 1921 until June 1932 (11 years). This is obviously very different from a –35% drop. In the 4.3 years from June 1970 to October 1974, stocks actually lost –22.8%, showing the effects of high and rising inflation. Today, on this basis, stocks have returned –16.9% since October 2002. Using this approach, then, it seems that the worst-case bottom should be another 7.1% below today’s close.
In reality, the numbers above are just guesses as well, and not supported by financial theory. But it’s interesting that very different approaches yield a fairly narrow range of results. Either the bottom is right around where we are, or it’s between 7% and 24% lower. Either way, with the S&P 500 already –57.1% below its 2007 high, the lion’s share of the drop certainly seems to be behind us.
I don’t know whether the above is encouraging or discouraging. But either way, it’s really the wrong question to ask (after all that, you say!). The near-term market bottom is not only unknowable, it’s irrelevant to a long-term investor (at least from a rational point of view; emotions are an entirely different thing). What counts is where stocks will be in 5, 10, 20, even 30 years. That’s because stocks are a long-term investment by definition. Even an 85-year-old couple has a joint life expectancy of over 10 years, and a 65-year-old retired couple could easily see one spouse live for over 30 years. So don’t say you’re too old to look that far into the future.
So let’s look into the future by looking at the past. Review the graph below, which shows total return after inflation for the S&P 500 from 1871 through today. (Don’t worry about reading the dates.)
The squiggly blue line is the actual return from stocks, while the straight black one is a trend line that shows the average return over a period of nearly 140 years, including the recent bear market. Note that while actual stock returns have strayed both above and below the trend line at various times, they never stray that far before “reverting to the mean.” The greatest drops below the line were in 1920 and 1932. Stock returns remained moderately below the line from 1974 to 1987, as well as for most of the period from 1932 until 1954. But the reversion to the mean during these periods resulted in some fabulous bull markets.
Note where we are today: about the same distance below the line as we were in 1982. Unlike 1982, it took only months, not years, to get there. In 2000, we were well above the line, but the 2000–2003 bear market took us back to trend. The current bear market started with stocks only a little above trend, far less so than in 2000, the 1960’s or 1929.
Could we go further below the line, either in the short term or sometime down the road? Of course we could, and there’s no way to know. But the more important point is that sometime in the next decade or so, we should get back to trend, and possibly rise above it again, at least temporarily. This would result in abnormally high returns for stocks during that period.
To get an idea of what that future return might actually be, I extended the trend line for 13 years past June 2008, when the market most recently dipped below trend. I used 13 years because that’s how long it took the market to recover to trend after first falling below it at the end of 1973. If the market recovers more quickly that that, returns will be higher; if more slowly, returns would be lower.
The trend line return, by the way, is +6.61% per year (remember, this is after inflation). Real purchasing power doubles in about 11 years at this rate. Now, if we return to trend from here over the next 12 1/4 years, that implies an average annual return, after inflation, of +12.23%. At this rate, real purchasing power doubles in less than 7 years; after 12 1/4 years, your purchasing power would have increased over 4 times.
Could such an optimistic scenario come true? We obviously won’t know for sure until more than 12 years have passed. But total real returns of this magnitude are not out of line with prior bear market bottoms: comparable period returns were +12.31% after 1932, and +9.72% after 1974. As you can see, inflation was a great drag on returns during the latter period, even though during and after the Depression it took much longer (22 years vs. 13) for stock returns to revert to trend.
Although I don’t know for sure whether +12.23% will be close to the actual return experienced over the next decade or so, I am sure that the path will be anything but smooth. There will be great rallies and bull markets, as well as scary corrections and probably at least one bear market during this period. But the overall trend should be decisively up, and at a rate that is both historically high and better than most other investments (cash, bonds, commodities, real estate, etc.). The price one pays for this higher rate of return is more volatility, which on rare occasions reaches the crisis proportions we see today. But no crisis lasts forever.
One other thing I know by looking at the graph above is that the bear market of 2007–2009 will go down in history alongside the great bear market of 1929–1932 as one of the 2 worst ones in US history. We’ve had other severe bear markets, but none as sharp and brisk (or as scary) as these two. But a further examination of the graph might give one hope: the sharpest bear markets have historically been followed by the strongest rallies. This one should, too. Now if only I knew exactly when it will start!
Tuesday, March 3, 2009
The daughter of all bear markets?
The bear market of 2007–2009 is now officially the second worst in US history, exceeded only by the mother of all bear markets, the one from 1929–1932 that coincided with the initial years of the Great Depression. Thus, we have no viable model to use in estimating the trajectory of the current bear market, except for the “big one.” It’s for that reason we see more and more pundits throwing out numbers where they guess this one will bottom: Dow 6000, Dow 5000, etc. But these are really no more than wild guesses, and have no basis in either history or current reality. There’s just no way to know when or where the bottom will finally occur.
As much as I loathe to do it, however, I will draw some comparisons between today and those fateful years in the early 1930’s. First, I’ll model what would happen should things actually get that bad again. Then I’ll give a bunch of reasons why they almost certainly won’t.
The S&P 500 is now -55.8% below its all-time high from October 2007, and the Dow is down -52.9%. These are both greater falls than in any prior bear market other than 1929–1932. Overseas markets are down even more: the Nikkei average of Japanese stocks, for example, is down -61% from its high. These are big numbers by any measure.
If this were 1930, though, we’d be only about halfway done. The US market would have another -63% to fall before hitting bottom in mid-1932. That’s a frightening prospect! Certainly, few people held on during this period, with many of them selling out near the bottom in 1932 (most of the rest were forced out earlier because of margin calls and the need for cash to live on).
But suppose you had held on, not expecting the market to continue to plummet, and knowing that it would eventually recover. How long would you have had to wait to make your losses back?
Not as long as you might think. You would have recovered your money from that second sickening drop and be back to your 1930 balance by March 1934, or about 20 months after that final bottom. By February 1937, about 3 more years, you would have recovered 81% of your money from the 1929 peak. This, of course, assumes you stayed 100% passively invested in stocks the entire time, not trying to own the better stocks, countries or industries. (These numbers include dividends, which remain an important part of stock returns.)
In real terms, the numbers look even better, because the 1930’s were a time of significant deflation, which itself contributed both to the drop in the stock market and the downturn in the economy. That’s why governments are so intent on avoiding deflation today. So, after inflation, you would only have had to wait until May 1933, or 11 months, to earn back that second drop. And by February 1937, you would have earned back 99.5% of what you had in August 1929, before the “Crash.” So in the greatest bear market in world history, it took less than 5 years from the bottom to earn back everything you’d lost. Bad, but not the end of the world. (Not only that, but US GDP had actually reached 1929 levels by 1936.)
So now you know what the worst case looks like. Now I’ll tell you why, as bad as things seem, they are not even close to the 1930’s, and extremely unlikely to approach that level of economic or financial decline.
1. The economic decline is not even in the ballpark of the 1930’s: Even the worst-case scenario sees a 5% drop in GDP during this recession (it was -3.4% in 1973–75 during the oil embargo). From 1929–1932, real GDP dropped nearly 30%. Unemployment may well reach double digits this time (as it did in 1982); in the 1930’s, it exceeded 25%.
2. As bad as things are with the banking system, it’s in better shape than in the 1930’s: Remember, mark to market accounting makes banks’ financial status appear much worse than they would under 1930’s accounting rules. And in the 1930’s, there was no deposit insurance, so runs on banks made some sense. When a bank went under, depositors lost most or all of their money. Thousands of banks failed in the 1930’s because of bank runs, which obviously severely reduced the amount of cash the banking system had to lend. This fed on itself, until the banking system was near collapse. It was only stopped by FDR’s bank holiday, shutting all banks for a week and then gradually reopening only the solvent ones. Also, today we have all sorts of government guarantees on bank liabilities, along with government programs to replace some of the lost lending.
3. US government responses were either inadequate or counterproductive until 1933: They actually raised some taxes and increased trade tariffs, as well as cutting government spending. Today, we’re seeing tax cuts and massive spending increases relatively early on.
4. The Federal Reserve didn’t have a clue in the early years of the Depression: They kept credit tight, allowing the money supply to plummet. This caused deflation to embed itself in the economy, leading to a downward spiral in economic growth that was difficult to reverse. Today, the Federal Reserve has not only reduced interest rates to near 0 and greatly expanded the money supply, it’s also working to lower long-term interest rates such as mortgages and implementing several new programs to provide liquidity and increase lending.
5. The US was on a gold standard until 1933: The gold standard was a big reason the Federal Reserve had such trouble increasing the money supply. When a country is on the gold standard, the amount of cash in circulation is limited by Federal gold reserves. And when people start trading in their dollars for gold (which was permitted then), this further reduces the cash in circulation. When other countries went off the gold standard before the US, this further drained our gold reserves. One of FDR’s very first actions, along with the bank holiday, was to take us off the gold standard. The economy then started growing almost immediately.
6. Protectionism and trade wars made the Great Depression even worse: This time, as I’ve said, protectionism is minimal. Governments around the world have dramatically loosened monetary policy and put large stimulus programs in place. In addition, there is a fair amount of coordination and cooperation between countries. In the 1930’s, we had a massive trade war with punitive tariffs, along with the rise of fascism in Europe that eventually led to WWII, something that we thankfully don’t have to contend with today.
Thus, while this recession is turning out to be the worst since 1982, and perhaps even become the worst since 1932, stock declines have already discounted something very severe, having been greater than any bear market since the Great Depression. I’ve listed above several reasons why it’s highly unlikely that the economy will sink anywhere near as much as it did in the 1930’s, and thus neither should the stock market. But given all that, it may be somewhat comforting to know that even during the economic Armageddon of the 1930’s, investors made virtually all their money back in less than 5 years by just sitting tight.
So given that neither I nor anyone else can predict the future, and given how far stocks have already fallen, and given the history of past bear markets, it seems to me that the bigger risk now is missing the rebound, rather than suffering a further big fall. I may be wrong this time (as I have been for many months now), but the longer this bear market goes, the closer we must be to the end. And the end will come when no one expects it, seemingly out of the blue, as has the end of every other bear market. I’m sure even I will be surprised when stocks finally decide that they can go up as well as down. And believe me, no one is more anxious to see this bear market end than I am!
In future emails, I’ll look more closely at the question of valuation (are stocks really cheap now, or do they just appear to be?), and finally explain mv=py and how it governs many of the Feds actions.
As much as I loathe to do it, however, I will draw some comparisons between today and those fateful years in the early 1930’s. First, I’ll model what would happen should things actually get that bad again. Then I’ll give a bunch of reasons why they almost certainly won’t.
The S&P 500 is now -55.8% below its all-time high from October 2007, and the Dow is down -52.9%. These are both greater falls than in any prior bear market other than 1929–1932. Overseas markets are down even more: the Nikkei average of Japanese stocks, for example, is down -61% from its high. These are big numbers by any measure.
If this were 1930, though, we’d be only about halfway done. The US market would have another -63% to fall before hitting bottom in mid-1932. That’s a frightening prospect! Certainly, few people held on during this period, with many of them selling out near the bottom in 1932 (most of the rest were forced out earlier because of margin calls and the need for cash to live on).
But suppose you had held on, not expecting the market to continue to plummet, and knowing that it would eventually recover. How long would you have had to wait to make your losses back?
Not as long as you might think. You would have recovered your money from that second sickening drop and be back to your 1930 balance by March 1934, or about 20 months after that final bottom. By February 1937, about 3 more years, you would have recovered 81% of your money from the 1929 peak. This, of course, assumes you stayed 100% passively invested in stocks the entire time, not trying to own the better stocks, countries or industries. (These numbers include dividends, which remain an important part of stock returns.)
In real terms, the numbers look even better, because the 1930’s were a time of significant deflation, which itself contributed both to the drop in the stock market and the downturn in the economy. That’s why governments are so intent on avoiding deflation today. So, after inflation, you would only have had to wait until May 1933, or 11 months, to earn back that second drop. And by February 1937, you would have earned back 99.5% of what you had in August 1929, before the “Crash.” So in the greatest bear market in world history, it took less than 5 years from the bottom to earn back everything you’d lost. Bad, but not the end of the world. (Not only that, but US GDP had actually reached 1929 levels by 1936.)
So now you know what the worst case looks like. Now I’ll tell you why, as bad as things seem, they are not even close to the 1930’s, and extremely unlikely to approach that level of economic or financial decline.
1. The economic decline is not even in the ballpark of the 1930’s: Even the worst-case scenario sees a 5% drop in GDP during this recession (it was -3.4% in 1973–75 during the oil embargo). From 1929–1932, real GDP dropped nearly 30%. Unemployment may well reach double digits this time (as it did in 1982); in the 1930’s, it exceeded 25%.
2. As bad as things are with the banking system, it’s in better shape than in the 1930’s: Remember, mark to market accounting makes banks’ financial status appear much worse than they would under 1930’s accounting rules. And in the 1930’s, there was no deposit insurance, so runs on banks made some sense. When a bank went under, depositors lost most or all of their money. Thousands of banks failed in the 1930’s because of bank runs, which obviously severely reduced the amount of cash the banking system had to lend. This fed on itself, until the banking system was near collapse. It was only stopped by FDR’s bank holiday, shutting all banks for a week and then gradually reopening only the solvent ones. Also, today we have all sorts of government guarantees on bank liabilities, along with government programs to replace some of the lost lending.
3. US government responses were either inadequate or counterproductive until 1933: They actually raised some taxes and increased trade tariffs, as well as cutting government spending. Today, we’re seeing tax cuts and massive spending increases relatively early on.
4. The Federal Reserve didn’t have a clue in the early years of the Depression: They kept credit tight, allowing the money supply to plummet. This caused deflation to embed itself in the economy, leading to a downward spiral in economic growth that was difficult to reverse. Today, the Federal Reserve has not only reduced interest rates to near 0 and greatly expanded the money supply, it’s also working to lower long-term interest rates such as mortgages and implementing several new programs to provide liquidity and increase lending.
5. The US was on a gold standard until 1933: The gold standard was a big reason the Federal Reserve had such trouble increasing the money supply. When a country is on the gold standard, the amount of cash in circulation is limited by Federal gold reserves. And when people start trading in their dollars for gold (which was permitted then), this further reduces the cash in circulation. When other countries went off the gold standard before the US, this further drained our gold reserves. One of FDR’s very first actions, along with the bank holiday, was to take us off the gold standard. The economy then started growing almost immediately.
6. Protectionism and trade wars made the Great Depression even worse: This time, as I’ve said, protectionism is minimal. Governments around the world have dramatically loosened monetary policy and put large stimulus programs in place. In addition, there is a fair amount of coordination and cooperation between countries. In the 1930’s, we had a massive trade war with punitive tariffs, along with the rise of fascism in Europe that eventually led to WWII, something that we thankfully don’t have to contend with today.
Thus, while this recession is turning out to be the worst since 1982, and perhaps even become the worst since 1932, stock declines have already discounted something very severe, having been greater than any bear market since the Great Depression. I’ve listed above several reasons why it’s highly unlikely that the economy will sink anywhere near as much as it did in the 1930’s, and thus neither should the stock market. But given all that, it may be somewhat comforting to know that even during the economic Armageddon of the 1930’s, investors made virtually all their money back in less than 5 years by just sitting tight.
So given that neither I nor anyone else can predict the future, and given how far stocks have already fallen, and given the history of past bear markets, it seems to me that the bigger risk now is missing the rebound, rather than suffering a further big fall. I may be wrong this time (as I have been for many months now), but the longer this bear market goes, the closer we must be to the end. And the end will come when no one expects it, seemingly out of the blue, as has the end of every other bear market. I’m sure even I will be surprised when stocks finally decide that they can go up as well as down. And believe me, no one is more anxious to see this bear market end than I am!
In future emails, I’ll look more closely at the question of valuation (are stocks really cheap now, or do they just appear to be?), and finally explain mv=py and how it governs many of the Feds actions.
Monday, March 2, 2009
In like a lion....
March certainly started off with a bang, as worldwide equity indexes plunged over –4%. We now appear to be watching “Panic, The Sequel.” But unlike the panic selling that occurred in October and November, which was justified to some degree because of fear that the entire global financial system could collapse, no such risk exists today. Governments worldwide have gone to extraordinary lengths to rescue the banking system and restart lending, as well as stimulate the economy. There’s no longer any question that we’ll come out of this crisis; the only issue remains exactly when, and how much more pain we might have to bear in the interim.
Concerns about bank nationalization should not be an issue, either, as the stocks of banks most at risk of being nationalized (here or abroad) already trade at prices reflecting this. And if nationalization of one or more US banks were to occur, the experience of Sweden in the 1990’s with their banking crisis should provide solace that such an outcome does not portend disaster.
Yes, AIG reported a huge $60 billion loss, but this has been expected for several days. And HSBC (one of the world’s largest banks) said it plans to raise $17.7 billion in equity—but this will be private money, not from the government. It’s actually impressive that a bank feels it can raise private funds without a government backstop. Moreover, most of the economic news today was better than expected. The ISM manufacturing index came in higher than anticipated. Personal income and spending both rose in January, while most people were expecting it to fall.
Oil prices dropped 10% today after rising strongly last week. But paradoxically, copper prices (as I’ve mentioned before, one of the early indicators of economic recovery) fell less than 1%, and copper remains well above its December lows. Even stranger, gold prices fell slightly as well, which you wouldn’t expect if investors were preparing for Armageddon.
So we’re seeing panic selling when the economic environment does not justify panic, and when trading in other markets suggests the opposite. What’s going on here? Why the panic selling? And when might it end?
Interestingly, the last 2 bear markets (1990–91 and 2000–2003) also had a secondary panic phase. Not only that, but both primary panics occurred in October, with the secondary panics ending 3 to 5 months later. We’re now just under 5 months from the October panic and 3 1/2 months from the November one. Seems we’re right on schedule.
Why has this pattern repeated itself? I suspect it has to do with the rise of hedge funds. These highly-leveraged investors sell heavily during the primary panic to rapidly reduce their leverage and meet anticipated redemptions. Other investors, such as mutual fund owners, follow the hedge funds’ lead as they see stock prices tumble. The primary panic burns itself out when the hedge funds stop selling.
The secondary panic starts with a more orderly decline in prices, driven largely by individual investors (including owners of mutual funds) and less nimble institutions such as pension funds, with hedge funds largely sitting it out. This is because they’ve already raised a large amount of cash and no longer have an urgent need to sell. Finally, having endured a couple of months of steadily falling prices, an ever greater number of investors throw in the towel and head for the exits. While all kinds of investors participate in this final market “blow off,” the driving force is the individual investor, who is typically the last one out, both at market bottoms and at market tops.
Trading data from the past several months support this scenario. Individuals have been big sellers since mid-January, while hedge funds have backed away from selling. This is also in keeping with the adage that the individual investor has the worst possible timing, selling at the bottom and buying at the top. Why should this time be any different?
Selling during a panic such as the current one can be very dangerous, because reversals tend to be rapid and powerful, as well as unexpected. And panics tend to be short: the rapid declines of last October and November each lasted only 5 trading days. During these brief stretches, stocks fell 22% in October and 18% in November. The current panic is now 3 days old, and the S&P 500 has dropped about 10% during that time. Obviously, I can’t say exactly how many days this one will last nor how much stocks will fall, but 5 days and 15% is as good a guess as any. In any case, it’s likely to be over very quickly.
Recoveries after panics can be impressive. In October, the S&P 500 soared 23% in only 2 1/2 trading days. In November, the surge was 21% in 5 trading days. In other words, the losses can be recovered almost as quickly as they occurred. One has to be extremely nimble to take advantage of such rapid price movements as they occur.
Because of the rapidity and unpredictability of panics, I tend to sit them out, neither buying nor selling. Sometimes, I’ll make purchases on day 4 or 5, but one has to be very brave to do so. It’s usually safer, and certainly less nerve wracking, to do so after the first definitive up day.
Bear markets are always unpleasant. This one has been the most severe since 1932, so it’s certainly normal to feel worried (or even a little panicked along with other investors) during these rapid down moves. But they all do end and give way to new bull markets. Even the one in 1932 did so, and provided investors with some of the most impressive returns in US stock market history. Investors who stayed the course from the high in 1929 to the recovery in 1937 made back 99.5% of their money after inflation. This is pretty impressive after the mother of all bear markets. 2007–2009 has been bad, but not nearly as bad as 1929–1932. And the recovery, when it finally comes, should be very profitable.
I know the temptation to sell now may be very strong. Obviously, lots of people are giving in to that temptation, which is exactly what is driving prices lower. But it will be a long-term mistake to do so, and perhaps a short-term mistake as well. And I’m not recommending anything different from what I’m doing with my own money, as my personal accounts remain heavily in equities. I feel the pain of loss just as much as you, but I also know that acting on that pain can make for very bad decisions. Sometimes doing nothing is the best course of action. Now may be one of those times.
Concerns about bank nationalization should not be an issue, either, as the stocks of banks most at risk of being nationalized (here or abroad) already trade at prices reflecting this. And if nationalization of one or more US banks were to occur, the experience of Sweden in the 1990’s with their banking crisis should provide solace that such an outcome does not portend disaster.
Yes, AIG reported a huge $60 billion loss, but this has been expected for several days. And HSBC (one of the world’s largest banks) said it plans to raise $17.7 billion in equity—but this will be private money, not from the government. It’s actually impressive that a bank feels it can raise private funds without a government backstop. Moreover, most of the economic news today was better than expected. The ISM manufacturing index came in higher than anticipated. Personal income and spending both rose in January, while most people were expecting it to fall.
Oil prices dropped 10% today after rising strongly last week. But paradoxically, copper prices (as I’ve mentioned before, one of the early indicators of economic recovery) fell less than 1%, and copper remains well above its December lows. Even stranger, gold prices fell slightly as well, which you wouldn’t expect if investors were preparing for Armageddon.
So we’re seeing panic selling when the economic environment does not justify panic, and when trading in other markets suggests the opposite. What’s going on here? Why the panic selling? And when might it end?
Interestingly, the last 2 bear markets (1990–91 and 2000–2003) also had a secondary panic phase. Not only that, but both primary panics occurred in October, with the secondary panics ending 3 to 5 months later. We’re now just under 5 months from the October panic and 3 1/2 months from the November one. Seems we’re right on schedule.
Why has this pattern repeated itself? I suspect it has to do with the rise of hedge funds. These highly-leveraged investors sell heavily during the primary panic to rapidly reduce their leverage and meet anticipated redemptions. Other investors, such as mutual fund owners, follow the hedge funds’ lead as they see stock prices tumble. The primary panic burns itself out when the hedge funds stop selling.
The secondary panic starts with a more orderly decline in prices, driven largely by individual investors (including owners of mutual funds) and less nimble institutions such as pension funds, with hedge funds largely sitting it out. This is because they’ve already raised a large amount of cash and no longer have an urgent need to sell. Finally, having endured a couple of months of steadily falling prices, an ever greater number of investors throw in the towel and head for the exits. While all kinds of investors participate in this final market “blow off,” the driving force is the individual investor, who is typically the last one out, both at market bottoms and at market tops.
Trading data from the past several months support this scenario. Individuals have been big sellers since mid-January, while hedge funds have backed away from selling. This is also in keeping with the adage that the individual investor has the worst possible timing, selling at the bottom and buying at the top. Why should this time be any different?
Selling during a panic such as the current one can be very dangerous, because reversals tend to be rapid and powerful, as well as unexpected. And panics tend to be short: the rapid declines of last October and November each lasted only 5 trading days. During these brief stretches, stocks fell 22% in October and 18% in November. The current panic is now 3 days old, and the S&P 500 has dropped about 10% during that time. Obviously, I can’t say exactly how many days this one will last nor how much stocks will fall, but 5 days and 15% is as good a guess as any. In any case, it’s likely to be over very quickly.
Recoveries after panics can be impressive. In October, the S&P 500 soared 23% in only 2 1/2 trading days. In November, the surge was 21% in 5 trading days. In other words, the losses can be recovered almost as quickly as they occurred. One has to be extremely nimble to take advantage of such rapid price movements as they occur.
Because of the rapidity and unpredictability of panics, I tend to sit them out, neither buying nor selling. Sometimes, I’ll make purchases on day 4 or 5, but one has to be very brave to do so. It’s usually safer, and certainly less nerve wracking, to do so after the first definitive up day.
Bear markets are always unpleasant. This one has been the most severe since 1932, so it’s certainly normal to feel worried (or even a little panicked along with other investors) during these rapid down moves. But they all do end and give way to new bull markets. Even the one in 1932 did so, and provided investors with some of the most impressive returns in US stock market history. Investors who stayed the course from the high in 1929 to the recovery in 1937 made back 99.5% of their money after inflation. This is pretty impressive after the mother of all bear markets. 2007–2009 has been bad, but not nearly as bad as 1929–1932. And the recovery, when it finally comes, should be very profitable.
I know the temptation to sell now may be very strong. Obviously, lots of people are giving in to that temptation, which is exactly what is driving prices lower. But it will be a long-term mistake to do so, and perhaps a short-term mistake as well. And I’m not recommending anything different from what I’m doing with my own money, as my personal accounts remain heavily in equities. I feel the pain of loss just as much as you, but I also know that acting on that pain can make for very bad decisions. Sometimes doing nothing is the best course of action. Now may be one of those times.
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