While 2017 brought us record-low volatility in the stock market, 2018 was quick to give us a quick (and sometimes painful) reminder that the stock market does indeed go down sometimes. In 2018 so far, the S&P/TSX Composite was down more than 7% in February and has now recovered to about flat for the year.
Even when we tell ourselves that markets can be (and often are) volatile, it still doesn’t take away the sting that comes when we check our account and see a lot of red.
Times like these can trigger a lot of questions: Could we have seen this coming? Is now the time to sell out and sit on the sidelines? Should we have listened to those pundits who said a downturn was coming?
You’ll find no shortage of headlines and analysts with predictions for where the market will be going this week, month or year. The allure of easy money – or avoiding losses by getting out before the rest of the crowd – rarely ceases to intrigue.
The thing is, for all the talk about cycles in the stock market or the multitude of predictions of where stocks will go in the short-term, I haven’t found anyone who has reliably outperformed the market averages over the long-term by timing the market and jumping in and out of stocks.
If anyone would know about stock market cycles, it's Jeffrey Hirsch. He literally wrote the book on them — The Little Book of Stock Market Cycles — and it was his group's research that popularized the trading dogma to "sell in May and go away."
In a 2012 interview, Hirsch shared his predictions for what U.S. stocks would do in 2013 and 2014 based on historical precedents and his own research.
Question: What impact do you think the 2012 presidential election will have on investors?
Hirsch: Presidential elections every four years have a profound impact on the economy and the stock market. After a president wins the election, the first two years are spent pushing through as much policy as possible. Frequently, the market, economy and country experience bear markets, recessions and war. Since 1941, the post-election year has posted the lowest average gain for the Dow Jones Industrials at 4.5%....
Slowing growth in emerging markets, a historically weak post-election year track record, the expiration of tax cuts, and unemployment benefits at yearend is likely to make for an exciting three-ring circus in D.C. after Election Day and plague stocks in 2013. Markets do not like uncertainty.
Unless a full-blown bear market occurs in 2012 or the market slogs along into the new year, market gains will be harder to come by in 2013 than they have since the March 2009 bottom….
2013 is another story. Markets are likely to come under pressure as whoever the president is will have tall orders to remedy the economy, the deficit and the dysfunctional government. The easy economic data and corporate results comparisons of the past few years will be gone. Foreign hot spots and diplomatic issues will also require renewed attention from the White House once the campaigning and/or inaugural balls are over. Central banking will remain accommodative, but there is little more they can do. After the yearend rally and positive 2012, I am concerned that the next major bear market will occur in the 2013-2014 period.
Hirsch's extensive research suggested that 2013 would be a tough time for stocks. The global economy was making a slow and stumbling recovery following the Great Recession, it was a post-election year in the U.S., and other seemingly negative factors were at play. Everything Hirsch was saying made sense at the time. Stocks were going to face an uphill battle in 2013.
Problem is, 2013 turned out to be a phenomenal year for stocks. The S&P 500 was up 29.6% for the year, its fourth-best year since 1975. The Dow Jones also had its fourth-best year since 1975, posting gains of 26.5%.
The major bear market — feared by many (myself included at times, admittedly) — didn't show up in 2014, either. Whoops.
Ironically enough, the three post-election years since the Great Recession (2009, 2013, and 2017) have been the best years for the Dow over the past decade (up 18.82%, 26.5%, and 25.08% in each of those years, respectively).
Of course, a market downturn will come at some point. It's inevitable. But even the so-called experts on stock market cycles — like Jeffrey Hirsch — don't have a clue when it will happen.
History supposedly told us 2013 should have been a bad year for stocks. That turned out to be glaringly wrong, and it likely cost some investors a lot of money through
1) needless speculative trading
and/or 2) opportunity cost from sitting on the sidelines during an incredible year for stocks.
Process vs. Outcome
So what can we take away from this?
First, markets are unpredictable in the short term. We’re not in the business of trying to time the market, because we won’t have a sustainable edge when it comes to predicting short-term movements.
Second, while we can’t control what the market (or the individual stocks we own) will do in the short-term, what we can control is our investing process. Rather than focus on shorter-term outcomes (like where our stocks are today compared with a month or two ago), we’ll instead focus on establishing and maintaining a process that – more often than not – will lead to market-beating returns over the long haul.
Third, we can save ourselves a lot of trouble (and money) by simply sitting on our hands and holding quality businesses for years (and decades) at a time, even in the years when market forecasters like Jeffrey Hirsch are worried that a bear market is right around the corner.
If we build a diversified portfolio of quality businesses we’re confident can grow and become more relevant over the next five years and beyond, it makes it a little easier to stomach volatile times (such as what we’ve experienced so far in 2018) and keep the bigger picture in mind.
Put another way, the longer our time horizon as investors, the less consequential inevitable short-term market declines become.
Warren Buffett spoke on this in his 2014 letter to shareholders:
For the great majority of investors, however, who can — and should — invest with a multi-decade horizon, quotational declines are unimportant.
Investors, of course, can, by their own behavior, make stock ownership highly risky. And many do. Active trading, attempts to "time" market movements, inadequate diversification, the payment of high and unnecessary fees to managers and advisors, and the use of borrowed money can destroy the decent returns that a life-long owner of equities would otherwise enjoy.
Anything can happen anytime in markets. And no advisor, economist or TV commentator — and definitely not Charlie (Munger) nor I — can tell you when chaos will occur. Market forecasters will fill your ear but will never fill your wallet."
The Foolish Bottom Line
In short, you shouldn’t “sell in May and go away.” This short-term mindset eliminates your greatest asset as an investor: time.
Time is your greatest advantage as an investor. The longer your investing time horizon (think in terms of years and decades, not weeks and months), the higher the odds you’ll come out ahead as an investor.
Don’t let the inevitable short-term market volatility – and the countless predictions from market forecasters – distract you from the long-term journey and your ultimate goals.
In our flagship investing service, Stock Advisor Canada, our investing process remains consistent through thick and thin. We’ll always be thinking more about where we think stock prices will be three years from now, not three weeks.
This disciplined focus on process is a big factor in why our stock recommendations in Stock Advisor Canada are trouncing the market’s return since inception. I encourage you to take a long-term mindset like us and to build a portfolio of quality businesses poised to become more relevant over the long-term.
David Kretzmann