Some hard-won investing lessons
When stocks are flying high, it’s easy to think you know more about investing than you really do.
Then, when you come up against challenging markets like we’ve seen since the pandemic struck, it can be an eye-opening learning experience from a tough teacher.
Here are five hard-won investing lessons derived from recent market events and earlier history. 1. An occasional stock market crash is a fact of investing life that you need to live with
The dramatic drop in stock prices starting in late February is a reminder that you always need to be prepared for market meltdowns. Unfortunately, while you know they will occur, you can’t reliably predict when. That means you can’t invest in stocks in the good times but then avoid the meltdowns.
In the 75 years since the end of the Second World War, there have been 12 stock market declines of 20 per cent or more, which is the common definition of a bear market. (My stock market statistics for this column reference the widely followed S&P 500 stock index, and data at yardeni.com and markets.businessinsider.com.)
While they all have a punishing impact, each bear market is different. The crash in February-March was fast and scary and driven by the pandemic — the S&P 500 fell 34 per cent in 33 days.
The plunge of 2007-2009 originated in excessive global lending (especially U.S. subprime mortgages) but then devastated an unprepared global banking system. In that case, stock prices fell 57 per cent over 17 months.
2. Markets are resilient and will reward the patient investor
After the alarming plunge in February and March, the S&P 500 rebounded more than 40 per cent in 2-1/2 months. That dramatic recovery made up most of the lost ground, although prices have
subsequently faded a bit.
Does that mean that the recovery is on solid footing and stocks will continue on to new highs from here? No one knows. It’s also possible that a strong second wave of the pandemic could trigger another cliff-dive in stock prices. All you can say with confidence is that the world economy — and stocks with it — should recover in a sustained fashion at some point. That means you may have to be patient. Consider what happened after the 2007-2009 market crash. After several false rallies, the stock market finally hit bottom on March 9, 2009. The recovery in the S&P 500 was rapid at first, rising more than 20 per cent in 10 trading days. But subsequent progress was uneven and it took a lengthy climb to get out of such a deep hole. It required roughly four years from March 2009 to March 2013 for stock prices to get back to the precrash high point. It continued to chug along, turning into one of the great bull markets of all time. In a period of just under 11 years up until February of this year, the S&P 500 grew by roughly 400 per cent.
3. Don’t let your emotions keep you from making smart investing decisions.
When markets move in dramatic fashion, our emotions encourage us to do precisely the wrong thing at the wrong time. When stocks are crashing and we’re feeling anxious, we’re tempted to bail and thus “sell low.” When stocks are soaring and we see lots of money being made, we’re tempted to load up and thus “buy high.” Unfortunately, the combination of “selling low” and “buying high” is a surefire way to achieve poor investment results.
The thing is, if you bail on stocks when they’re down, it’s really hard psychologically to buy back in. When stocks drop, it’s really easy to rationalize that you’ll sell for now and then buy back when the market “stabilizes.” That sets you up for what Tom Bradley, chair of Steadyhand Investment Funds Inc., calls the “toughest decision in investing.” Once you’ve been burned once, you’ll probably be extra cautious about buying back because you’d really hate to be burned a second time.
And timing your return to the market can be hard. You won’t be able to tell when stocks have hit bottom until well after the fact and prices don’t necessarily “stabilize” at a low point. If you mull over your repurchase decision for a few weeks, stock prices may have already advanced 10 or 20 per cent higher than the point at which you recently sold them, which makes repurchasing them a bitter pill to swallow.
On the flip side, the dramatic recovery in stocks from March to early June provided immediate relief to those investors who had the fortitude to hang on through the fierce down drop.
As the rebound gathered steam, an entirely different set of emotions was unleashed, mostly among a different set of investors. Those bullish emotions have encouraged investors to keep buying as prices rose higher. While prices haven’t fully recovered to the all-time market high point achieved in February, they nonetheless seem on the high side considering that we’re in the midst of a pandemic.
Legions of new day traders have suddenly jumped into the market, fuelling each other’s bullishness on social media, at times to extreme levels. They appeared to be responsible for some odd happenings, including a big upward spike in the stock price of newly bankrupt companies like Hertz, the car-rental company. Most famous among the new day traders is Dave Portnoy, the founder of the Barstool Sports website with 1.5 million Twitter followers, who gleefully disses established investment experts like Warren Buffett and repeatedly proclaims “stocks only go up.” While such provocative statements may be more of a ploy for social media attention than sincere investing advice, it’s nonetheless a clear expression of bullish extremes.
4. Your adviser has had a golden opportunity to prove their value — or not
Financial advisers take a lot of heat these days for the fees they charge, often for good reason. But it’s challenging times like these that give great advisers a chance to shine and provide tremendous value that far exceeds their fees. Of course the opposite is true also. If your adviser hasn’t done a great job at helping you to get through this crisis, then it is probably time to consider taking your business elsewhere.
Here’s what your adviser should have done before the crash. When they set up your account, they should have made it clear that a market crash that is worse than what just happened is likely to occur at some unknown point in the future and warned you to be prepared for it. With that in mind, they should have helped you gauge your appetite for risk, then helped you to design a portfolio that would withstand a crash without the need to sell stocks at distressed prices. In subsequent conversations — especially when the market is flying high — they should have reminded you of those risks.
When the market crash happened, your adviser should have provided a calming presence, easing your anxieties and reminding you such an occurrence was anticipated. Furthermore, they should be able to show how your portfolio was designed to withstand such an event as long as you “stayed the course” and didn’t sell at distressed levels. They should also have broached the topic of rebalancing and possibly started helping you do so, although there is no one right rebalancing approach. If the market crash totally blindsided you and your portfolio was unprepared for it, then either your adviser did their best to educate you and you ignored them, or it’s time to take your portfolio elsewhere.
5. The everyday business world and the economy drive the stock market, but it isn’t a simple relationship
A lot of people were surprised that stock markets bounced back while the COVID-19 death toll rose and much of the global economy was shut down. On the face of it, it sure seems like a big disconnect.
While stock prices do in fact reflect an assessment of corporate prosperity, it’s important to realize it isn’t a simple relationship. The initial bounceback in stock prices came as the result of an improvement in market sentiment after dismal lows. That initial recovery in stock prices amounted to climbing up from the bottom of a deep pit.
Also, stock prices reflect investor expectations of corporate profitability years into the future. So, in effect, the stock market to a large extent is looking past the global shutdown to years of profits after the economy has recovered.
The catalyst for the bounce were actions by central banks and governments around the world to resuscitate the global economy with unprecedented fiscal and monetary stimulus. That has encouraged markets to believe that the recession will be relatively short-lived and that the business recovery will be strong.
Of course, that doesn’t mean markets have got their expectations right or that market sentiment won’t change again for the worse. If there is a strong second wave of COVID-19, followed by a second global wave of shutdowns, then stock prices might plummet again. But don’t think that what you see in the headlines or the economy will necessarily be reflected in the stock market in a straightforward and direct way.
David Aston, a freelance contributing columnist for the Star, is a personal finance and investment journalist. He has a chartered financial analyst designation and is a chartered professional accountant. He is also author of “The Sleep-Easy Retirement Guide,” published earlier this year. Reach him via email: davidastonstar@gmail.com