“Look at market fluctuations as your friend rather than your enemy; profit from folly rather than participate in it.”— Warren Buffett
The first stock exchange, the Amsterdam Stock Exchange, was founded in 1602 by the Vereenigde Oost-Indische Compagnie (VOC) to facilitate the purchase and sale of that company’s stocks and bonds. Initial shares of the company we know as the Dutch East India Trading Company cost buyers 100 guilders and had doubled in value by 1607. Not long after, the first bear market was born when short sellers successfully drove the stock price down by more than 40%. There would be several more bear markets in the stock over the next 100 years and each one proved to be a buying opportunity. Investors that bought or held their shares in bear markets saw the stock price climb as high as 1,000 guilders while collecting an annual dividend averaging 18%.
400 years later, market fluctuations are still with us and will be with our descendants 400 years from now. Unfortunately, the 18% dividend yields are probably gone forever.
Over the first seven months of 2015, a large majority of stocks were range-bound and the yield on the 10-year U.S. Treasury stayed under 2.5%. Investors shrugged off numerous storm clouds on the horizon, including a bear market in commodities, slowing global economic growth and the standoff surrounding the near-insolvency of the Greek government. Market fluctuations were largely kept at bay until Chinese Central Bank officials surprised the global financial markets by devaluing the yuan in mid-August, sending markets into a sharp decline worldwide.
All of the major U.S. equity indices experienced their first correction (declines of 10%+) since the Fall of 2011 and ended the quarter with losses in the mid to high single-digits. Investors were likely reluctant to even open their 3rd quarter statements as many have not fully recovered from the pain inflicted during the 2008 bear market.
The level of worry permeating the markets can be illustrated by reviewing the recent performance of the CBOE Volatility Index, better known by its ticker symbol VIX. The VIX has become an important indicator investors use to measure the current level of fear in the financial markets and is commonly referred to as the “fear gauge” for the stock market. The magnitude of August stock market volatility spike in the VIX was immense. Volatility increased 135% from the prior month, which blew away the previous record by a wide margin.
What does all of this mean? As illustrated earlier, volatility and market fluctuations have been with us as long as stock markets have existed. To be successful long-term investors, we must limit the role we allow our emotions to play in our investment decisions. Consider that, since 1980, the S&P 500 has AVERAGED intra-year declines of over 14% per year. If we focus only on that statistic, any sensible investor would avoid the stock market altogether. Fortunately for investors, a closer look reveals that those intra-year losses reverse themselves by the end of the year nearly 80% of the time (see Figure 1 below).
What about the other 20% of the time? The vast majority of bear markets have coincided with or overlapped economic recessions. As such, we regularly monitor a multitude of economic indicators to determine if the odds of entering a recession are elevated. Currently, they indicate the probability of a US economic recession is exceedingly low.
Do you have questions about the markets? Are you concerned about how the Fed’s outlook might impact your investments? Have your goals changed recently?