The recent 8.2% dip in stock indices from their January 15th peak provides an opportunity for reflection. While market declines in general are not pleasant, one can understand investors are understandably squeamish after the 37% drop in 2008 and the peak-to-trough drop of 57% from October ‘07 to March ‘09. But ever since stock markets began, values have dropped then recovered only to go on to new heights. Our purpose today is not to predict the market’s next move, but to objectively examine its nature and demonstrate why worrying about the dips is needless and avoidable.
The week’s economic data continues to point to recovery, but investors worry whether it will be strong enough to support the stock rally since March 9th. The S&P fell 2.6% this week as of yesterday’s close. September is historically the worst month for the stock market. In fact as Ed Yardeni notes, since 1926, September is the only month with a negative average return. Investors lose an average of 1% during September compared to a 1% return for the other 11 months. So the market may be in a holding pattern for a while. This is a good time to forego analysis of the various economic and market wiggles to take a broader and longer perspective on investing.
During the lifetime of the “Greatest Generation” the market has fallen an average of 40% fourteen times, or once every 5.7 years. In fact the odds of an investor experiencing a loss in any one year are 1 in 3.9. The latest drop from May 19, 2008 to March 9, 2009 took us down nearly 53%. It’s easy to see why so many former investors have been driven to the sidelines. Yet why do others remain steadfastly invested? In short they seek the 11.5% average annual return the market has provided for the past 40 years, along with the added benefit of ready liquidity. They understand the market, while seductively steady much of the time is prone to major emotional swings which require patience and fortitude to endure. Perhaps knowing that the average return a year after a market trough is 46% helps assuage the pain of declines, while understanding that ‘irrational exuberance’ will eventually lead to a hangover helps them remain on course while others fall prey to their emotions.