In 1997, my colleague Harvey Siegel in our Lenox, MA office, wrote about market volatility. He cited the fact that from 1990 through 1997 the US stock market (S&P 500 index) gained 300% and that investors should not expect a move like this to continue unabated. After all, market volatility is the price we pay to get the market return. Due to market gyrations last summer, Harvey and his partners, Ed Richter and Barry Wesson, revisited that column. Considering the past few week's market moves, I thought it deserved yet another look and it's re-posted here:
It’s been a rather long time since the stock market gave us a good scare. Not since the late 2000s has there been an opportunity to buy stocks after they lost significant value. We’ve had a few dips since, but even those were mostly shallow and followed by striking, often breathtaking recoveries.
Given the outsized returns of the past eight plus years, it should not surprise that, using most traditional measures of valuation, domestic stock markets are richly priced. There are arguments to the contrary, one being that modest growth with low inflation will keep interest rates low providing fuel for continued gains. Well, maybe. Whether current conditions reflect a new model for evaluating market valuations will remain unknown. What is known is that valuation methods are imperfect, not necessarily enduring and offer few clues as to the timing, magnitude and duration of future market returns. Also known is that this strong positive period, like all others, will end and markets will decline. Stock market declines are a historic certainty, if not an economic necessity. At that point, what the markets do won’t matter as much as how one behaves. That behavior will largely result from fear. When markets go up, there is little resistance to the notion that they will go up forever. When markets fall, one presumes catastrophe.
We’ll deal here with irrational fear. We’ll assume our investor’s investments are diversified and within a suitable financial risk tolerance. Most important, withdrawals are not substantial and will not become so in the near future. Regardless, many will decide a decline is too painful and will panic out of their stocks - or worse, sell in anticipation of an impending calamity. Our investor’s stock holdings should remain a consistent portion of investments regardless of what the market does or what they think it might do. If a temporary reduction in capital won’t change your life, stay the course and let heirs worry about market risk. Losses are made by investors, not markets. A temporary decline in a diversified stock market is just that, temporary. The only bad news in a decline is for those who will be tempted to turn a temporary decline into a permanent loss by selling.
So for now, tack this column to the refrigerator door. Save it for a rainy day. Should the time come when you are tempted to turn a temporary decline into a permanent loss, take it out and read it again. The rules for creating wealth in the stock market have not changed. The first requirement has apparently been satisfied - you bought. The second may be more difficult - you got to hold.