Hello friends. It’s been a couple months since I wrote my last newsletter.
Here’s a snapshot of what the market has done in the interim … nothing. Crazy, right?
The S&P 500 went down a lot in June and early July. It proceeded to go up a lot from the end of the July to mid-August. And now it is trending down again. There are a myriad of factors one could point to in an effort to explain these movements: Fed Commentary, Inflation indicators, Economic indicators, Unemployment Results, Corporate Earnings, etc.
I’ll be honest, I don’t have a strongly held opinion on which of these factors is the most important for the market right now. Part of the reason I held off writing a newsletter is I don’t know exactly what is driving the market movements. I’ve come to realize that doesn’t matter. Instead, I think three newsletters I wrote over the past three years provide a very good framework for how one should think about investing in this current environment, and really any environment.
Are things perfect? No. Things will never be perfect. If the last 100,000 years of human history provide any guidance, it is that over the long-term, we will adapt, survive, and thrive. That’s a pretty good track record on which to base optimism.
Now how does this impact my investing?
Simple. I am extending the frame of my perspective. It is impossible to turn on the TV or read an article not highlighting the troubling events unfolding before us. Fortunately, the events of the next 6, 12, or 24 months represent a chapter in a much longer story. Understanding what is happening today and how it will impact the businesses that I own is important. Having answered that question, my attention has turned to focusing on the next few chapters. I am looking for businesses and industries that will come out of today’s environment stronger than they entered.
The most common opportunity cost I come across is people asking me if now is the correct time to invest. My answer is always yes and no. Yes. If you have a plan and a long enough horizon, it is always a good time to invest in the market. No. Chances are every investment you make will be negative at some point in your ownership. The ability to perfectly time when to invest is not something I possess. I am a firm believer time in the market is more important than timing the market!
There are two implications from this chart. First, on average the market declines >25% once every fifteen years. Since 1993 (28 years ago) there have been three periods where the market declined by >25%: 2000-2002 during the dot-com bubble, 2008-2009 with the Global Financial Crisis, and the COVID-19 pandemic in 2020. Now all you math whizzes are probably saying, “Bill, how could it be fifteen years on average if we’ve had three events in the last 28 years?”
Simple. Each of these events proved to be transitory, highlighting how short lived steep market declines tend to be. The longest stretch was 308 days following the dot-com bubble. Between both the Global Financial Crisis and COVID-19 Pandemic, there were 103 days (3.4 months) where the market declined by >25% over a three year period. The length of the dot-com bubble decline makes sense considering the speculative excess in the market leading to the bubble.
The psychological benefit of investing money and immediately seeing an increase in value can be intoxicating. The flipside is also true. Investing money and seeing it immediately decline in value can be demoralizing. However, these values represent just a moment in time. If you have a plan and can stick to it, the best outcome for long-term wealth creation is actually counter-intuitive.
As you can see, Scenario B does better up until the very end. This dynamic can be explained by the power of compounding. In Scenario A, the investor gets to invest for the next ten years at lower valuations stemming from the decline in Year 1. The opposite is true for Scenario B who sees a 25% decline in Year 10. Yes, it is painful to see $100,000 go to $75,000 over twelve months. However, that person had an additional $100,000 they invested over the next decade at lower valuations. This dynamic drove a 15% difference in total returns or ~$34,000 between Scenario A (~$266,000) and B (~$232,000). So what was painful in Year 1, proved to be fortuitous by Year 10.
What’s the narrative from these three quotes?
Things at the moment are a mixed bag. Markets always extrapolate near-term risks into perpetuity. Here are some of today’s boogeymen: inflation, interest rates, housing, China/Taiwan, Russia/Ukraine, and energy. I’m sure I missed a few! Look back two years ago and none of these narratives were driving the S&P 500. All anyone cared about was COVID. The point is there is always going to be risks with investing. You are exchanging the certainty of your cash today for ownership of a business you believe will be worth more in the future.
If you own good businesses with strong management teams they tend to find ways to navigate the uncertainty of today. You may not know exactly how they are going to do it, but you know they have the knowledge, intelligence, and adaptability to overcome these obstacles to reach their long-term goals. The same is true for me. I don’t know what is going to happen in the market over the next six to twelve months, but I do know I have the capabilities to overcome whatever obstacles get thrown my way!
