In these economic times, investors are challenged to believe that they are still on the right track for investing. Quite simply, this global economic crisis has had the ability to shake one’s confidence in their investment strategy.
Given the magnitude of global news headlines and market behavior, it is easy to believe one is not on the right investment path. During extreme market declines such as the one we are in, you might think that selling all your investment and going to cash is the right thing to do. An investor may have a unique need that dictates a certain course of action away from the following recommendations, but generally speaking, selling assets in a declining market is the wrong action to take.
Over long periods of time, world economies will grow and then they will decline. It is very much a part of the business cycle. The good news is that in recent decades economic declines have been shorter (14 months) and the economic expansions (68 months) have lasted longer. Yes we are very much in a recession today; an economy, which is not growing. But guess what all recessions have in common, a beginning and an end. The current recession was recently announced as having begun one year ago, December 2007. I actually find that good news. Why you ask? The typical recession last only 14 months as reflected above. There have been nine ‘official’ recessions since 1949. (See chart below)
We are in the tenth recession now. There have been very few recessions that lasted greater than 14 months, something closer to 24 months in duration. I am not to predict the length of this current recession, but to merely note that this recession will probably last longer than the average one. Anyway you look at it, the current recession will end, and thus the first major point for you as an investor to understand.
1st Key Point:
Stock markets, on average, rallied over 34% one year after a recession ends, and economic expansions last, on average, 68 months for a cumulative gain of 176%
2nd Key Point:
Much of the investment return occurs within the first three to six months of the rally.
This generally happens while economic news is still negative. Note the chart above, 15% return in first 3 months of recovery after a recession and 23% return within six months, on average. If an investor is in cash, they lose out on much of the recovery the markets have to offer.
3rd Key Point:
Stock markets recover well before economic news turns positive.
Financial markets are always looking into the future to determine their direction. In the chart below, we can see the S&P 500 index from 1974 through 1975. The three rectangle boxes reflect negative economic growth from Oct 1974 to July 1975 as measured by US. Gross Domestic Product, GDP. Note how the market rose during that same time frame, well over 40% in just nine months and over 30% in twelve months, October 1974 to October 1975. The negative headlines of the day were plentiful; Nixon, Watergate, gas shortages, inflation etc.
This is what financial markets do; they will go up even while the current economic news of the day is negative. As Warren Buffet has said, ‘If you wait for the robins, spring will be over’.
Another way to look at markets rising with bad news is with unemployment data. Twelve months after unemployment peaked within a given recession, the S&P 500 index rallied, on average, 29%. Note chart below.
4th Key Point:
Do not try and ‘time the market’.
This is to say, sell your assets now and wait a better time to reinvest in the future. It is widely known that market timing is nearly impossible to do successfully. The key word here is ‘successfully’.
I will recast work from my January 7, 2008 blog to help answer the question, why such poor investor behavior?
‘The Penalty for Missing the Market’ is a study frequently created by Wall Street investment firms reflecting the S&P 500 index over long time periods and what happens to returns by missing just a few days in the market. I have referenced a January 2007 Goldman Sachs report.
Simply put, when markets move, they do so in short, quick, explosive measures. If investors are not in the market on those very few powerful, explosive days, annualized returns will suffer greatly. As the Goldman report states, “Two Potential Keys to Success: Patience and Commitment” Enough said! Hey if investing was so easy, we might all be retired by now, right?
Average Annual Total Return: 1985-2006
S&P 500 Index 12.12%
Missing the 10 Best Days 8.56%
Missing the 40 Best Days 1.87%
Missing the 70 Best Days –3.02%
If I could forecast the next best 70 days to invest over the twenty years, I would, but it cannot be done.
Lastly, it is ok to recognize that investment time periods like this are emotional. It is what makes us human. But we have to be careful to not let our emotions control our investment process. In fact, our investments and their allocations must be based upon well-laid plans that endure in all financial and economic environments. Are your investments and their allocations well planned, can they endure all economic environments?
5th Key Point:
Have a well-laid investment plan. Your investment plan should based upon factual, sound investment processes and one that is not based upon emotion.
Summary
It is very easy to want to sell your investments and go to ‘safe’ alternatives such as money market funds or certificates of deposits to weather the storm. Knowing all the information in this article, I can say that this recession will end and the markets will recover. As I heard it said in recent weeks, “its not what we own going into a recession, (investment wise) but rather what we hold coming out of the recession”
Make sure your investments are positioned properly for the next recovery.
1st Key Point:
Stock markets, on average, rallied over 34% one year after a recession ends, and economic expansions last, on average, 68 months for a cumulative gain of 176%
2nd Key Point:
Much of the investment return occurs within the first three to six months of the rally.
3rd Key Point:
Stock markets recover well before economic news turns positive.
4th Key Point:
Do not try and ‘time the market’.
5th Key Point:
Have a well-laid investment plan. Your investment plan should based upon factual, sound investment processes and one that is not based upon emotion.
Thanks for reading. I welcome your comments, concerns or questions.
Addendum:
Recent weblog postings containing much of the content found in this article.
Stock Markets Rally before Economic News Turns Positive:
Stock Markets Rally Before Economic News turns Positive, Part One
Stock Markets Rally Before Economic News turns Positive, Part Two
Articles on Recessions and Market Recoveries:
It’s Official, Now What and Where Do We Go from Here?
Recessions and Bear Markets: A History of Inconsistencies
Market Timing/Missing the Markets:
Emotions in the Investment Process:
Beware of the Hidden Cost of Cash
Just a reminder….Smart Investing Begins with a Disciplined Approach, not a Cycle of Emotion
