Skip to main content

Sound Advice: March 31, 2021

The Market Drops Every Year . . . and Ends Up Higher Over Time

The market drops I refer to take place over a period of a few months within one year or starting in one year and running into another.  These short periods of weakness are not to be confused with 12-month changes from yearend to yearend.

Since 1980, the Standard & Poor's 500 Index has had average interim drops of 14.3%.  In more than half of those years, the corrections, as they are euphemistically known, were 10% or more.  We hit the worst air pocket back in late 2008 to early 2009: 49%.

When this happened, more than a few investors started to wonder what was going on. Yet each time, the pullback was followed by a full recovery and annual returns ended up positive in three out of four years.

The lesson learned from this pattern is that short-term movements are for the most part reflections of changes in investor psychology.  One day, there may be a series of encouraging earnings reports.  The next day, there may be a disappointment or perhaps increased concern about rising interest rates.

Whatever the reasons for these interim shifts in stock prices, they tend to wash out over time.  And for that matter, any attempt to provide a rational basis for same is really an exercise in futility.

By analogy, consider the difference between the climate and the weather.  Data collected over extended periods makes it easy enough to suggest probable ranges of temperatures over the course of the year.  There may be minor variations, but summer usually looks like summer and winter brings Jack Frost (unless you happen to live way down south).

Forecasting weather, except perhaps a day or two before, is fraught with considerable risk. Even so, by comparison with market predictions, weather forecasting looks like a science of great merit.  Those who talk, often in measured tones, about where the market will end up – even on the same day – are just plain silly.  These things are unknowable.

As recently as the early morning hours after Election Day 2016, the Dow Jones futures indicated a plunge of more than 800 points.  But even that ominous foreshadowing was misleading.  The Dow finished the next market day with a gain of more than 250 points.

Since market valuations reflect underlying earning power, a constant multiplier applied to those earnings would yield what might be called a normal valuation.  A normal valuation, however, is rarely seen.  Higher or lower is more likely.

Over time, stocks generally sell in a range of 10 to 20 times earnings.  During the most difficult of times, as in the mid-1970s, multiples actually narrowed to high single digits.

From one standpoint, it was among the worst of times.  But when valuations get that low, it's usually a signal that stocks are on sale.  And they most definitely were.

Yet back at the beginning of the 21st Century, i.e., the dot-com era, stocks were selling at 20 to 30 times earnings . . . and higher.  Not surprisingly, it took more than a decade for underlying earnings to rise sufficiently to bring valuations back into a normal range.

So even though the concept of a normal value might be appealing, it's not a common occurrence.  Best advice: Ignore the noise of the moment and take the longer view. 

“We've long felt that the only value of stock forecasts is to make fortune tellers look good.  Short-term market forecasts are poison and should be kept locked up in a safe place, away from children and also from grown-ups who behave in the market like children.”

                                                Warren Buffet in his 1992 letter to shareholder

 

N. Russell Wayne, CFP®

Sound Asset Management Inc.

Weston, CT  06883

203-222-9370

www.soundasset.com

www.soundasset.blogspot.com

Any questions?  Please contact me at nrwayne@soundasset.com

Comments

Popular posts from this blog

Sound Advice: July 8, 2020

Jobs Are Up, But So Are New Infections Through the spring months, m ost of the economic data was extremely negative, with record declines in employment and consumer spending.  The speed of that decline had no modern precedent. We are now in a recession.   The shortest recession on record occurred in 1980 and lasted just six months.  Second place goes to a seven-month recession in 1918-19, which was tied to the Spanish flu pandemic.  The big question is: When will this recession end? Given surprisingly strong data in May, April may have been the bottom of this economic cycle.  If so, it will have been the shortest recession on record.  With massive support from the Federal Reserve, the federal government, and the reopening of previously closed businesses, employment surged unexpectedly.  At the same time, pent-up demand, stimulus checks, and generous unemployment benefits led to a reacceleration of commercial activity. Still, not all is rosy.   In his recent testimo

Sound Advice: May 17, 2023

Say hello to PEG No, she’s not a new neighbor.   PEG is the acronym for Price-to-Earnings Growth Ratio.   Although stock analysts tend to litter their conversations with shop talk such as PE (Price-Earnings Ratio), ROI (Return on Investment), and Debt-to-Equity Ratio, PEG may well be more telling about the level of stock valuations. The process of evaluating stocks begins with evaluations of the underlying companies.   This includes income statements (a.k.a., profit and loss statements) and balance sheets. Concerns about income statements focus on the trends in earnings, which include profit margins, tax rates, and net income.   What’s important here are the trends over time.   Are margins rising or at least holding their own? Are tax rates following a consistent pattern or have there been interim aberrations? And is the bottom line expanding? Flat or rising margins are good.   Level tax rates are also OK, but if there’s been an outlier, what would have been the impact on net i

Sound Advice: April 13, 2022

Tough Time For Bonds Over the years, difficult periods for the stock market have invariably prompted “flights to quality” on the part of investors.   In most cases, these shifts meant that funds were being moved from higher risk holdings to those appearing to offer increased safety.   That usually led to a redeployment from stocks to bonds, typically those of the U.S. Treasury or high-grade corporate borrowings.   With interest rates now rising, however, that approach is no longer working.  Indeed, in recent months it has backfired.  In the latest calendar quarter, the Treasury market posted its worst performance in more than 40 years.  For the period, the ICE 15+Year U.S. Treasury Index sustained a loss of 13%.  The iShares 20+ Year Treasury Bond Index dropped 14%. This is typical of what takes place when interest rates are rising.  The rule of thumb for bonds is that when rates rise, bond prices fall.  In most cases, the longer the maturity of the bonds, the greater the interim