Silver Linings

We all know people who are great to be around, and people who are quick to tell us all that is wrong in the world. The reality of life, business and investing is that there are benefits and limitations to every decision, and positive and negative aspects to every outcome, if a person seeks to learn and grow from experiences.

March has arrived after February broke a long monthly winning streak for the S&P 500. The S&P 500 declined 2.6% in February, which was the first negative month since October 2016 (Bloomberg.com). The historically low volatility in the stock market has been even more surprising to me. The investing seas since October 2016 have been incredibly calm until late January 2018.

We all prefer higher account values, which generally come from increasing stock market prices. An increasing stock market grows wealth and/or financial confidence for most everyone. So what would be the silver lining when the stock market declines significantly?

I’ve written often about the difference between speculators and investors; amateurs and professionals. When the stock market has low volatility and good performance, the amateurs and speculators leap in! Amateurs underestimate the inherent market risk and potential loss when the stock market is cruising upward. Speculators, who believe they can time the market and predict the future, are fooled by what starts to appear like predictable stock market performance in a low volatility bull market.

Investors and professionals are less affected by volatility, news headlines and short-term results. It isn’t a stretch to say that it does not matter much to a serious investor or professional. The upside to a stock market correction is to shake out the amateurs and speculators who can distort the stock market.

I apologize in advance if you dislike sports analogies. However, if you are a committed long-term fan of a sports team, you have probably noticed that when your team has a good year, there are a lot of fans that come out of nowhere! These “bandwagon fans” look and act just as committed as you. Opportunists are scalping tickets far above face value. The hype around any team doing well is inflated! However, as soon as the team loses a few games or is no longer in the headlines, these cheerleaders are nowhere to be found.

When the stock market abruptly declines or experiences a “correction”, which is defined as a 10% decline, the amateurs (Bandwagon fans) and speculators (Opportunists) are often shaken out of the market. This can effectively “re-set” the stock market to its fair value upon which legitimate growth may resume based on the fundamental qualities of the economy generally, and companies specifically. This is why you may have heard that a stock market decline is a buying opportunity for investors.

Amateurs, overcome by emotion, bail out on their investments or sports teams when the going gets tough. They may understand intellectually that it is a buying opportunity when stocks decline, but they cannot control their fear or avoid being guided by news headlines. Professionals, and amateurs who hire professionals, remain focused on investing objectives. If you have a short-term financial objective, then you have no business putting the money required for the objective in the stock market—period. If you have financial objectives 3, 5, 10+ years away, then a stock market decline is a buying opportunity!

Absorb this truth. We only know a stock market correction occurred, after it occurs. If I said you could purchase stocks today for 10% less than the actual stock prices today, would you want to do that? If you say no, please re-read the question. Of course you would want to buy stocks or anything for 10% less than current value! Therefore, if you don’t require currently invested money in the short-term, and stock prices decline 10% next week, why in the world would you ever sell?

Why would you choose not to buy at a 10% discount? At the point of making the decision to buy, sell or hold, the decision after a correction is the same as the hypothetical offer to buy stocks today for 10% less than actual stock prices today.

 

 

S&P 500 definition: The Standard & Poor’s 500 (S&P 500) is an unmanaged group of securities considered to be representative of the stock market in general. It is a market value weighted index with each stock’s weight in the index proportionate to its market value.

Disclosure: This material represents an assessment of the market and economic environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. Forward-looking statements are subject to certain risks and uncertainties. Actual results, performance, or achievements may differ materially from those expressed or implied. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice meeting the particular investment needs of any investor. Past performance does not guarantee future results.