Are we still having fun? I take no pleasure in seeing my portfolio shrink, but I love buying discounted stock index funds and am always amused by twists in the financial media.
Two years ago, we were hiding in our homes, worried about a global pandemic and worried about an economic collapse. Today, COVID-19 continues to spread like wildfire, but vaccines have helped reduce the number of hospitalizations and deaths, the unemployment rate is only 3.6% – barely above the 50-year low of 3.5% – and people are spending so happily that we’ve ended up with 8.6% inflation. Clearly, all is not well with the world, but that doesn’t seem to justify today’s widespread pessimism.
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In fact, you can count me among the optimists. Worried about your investment losses? Keep these four ideas in mind:
Expectations. The financial markets are already reflecting what has happened and what the consensus expects. Will the news in the months ahead be surprisingly bad, or not as bad as feared? If it’s the first, the sell-off on the stock market will probably last a few more months. If it’s the latter, we’ll look back and wish we had bought in June 2022.
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Story. If we include the Great Depression, the average bear market decline is 38%. The S&P 500 SPX,
is currently down 18% and it was down 24% at the start of the month. If this is a typical bear market, we’re about halfway there. My assertion: it is too late to sell.
Intrinsic value. As stocks tumbled in 2022, the return to investors – in the form of share buybacks and dividends – has risen from less than 3.5% to perhaps 4.2%. This higher yield suggests that the intrinsic value of stocks is also now higher. On the other hand, intrinsic value may have fallen because investors are now discounting corporate cash flow at, say, 10% rather than 8%, reflecting the greater uncertainty today.
If the intrinsic value has increased, it means that the stocks are worth more than six months ago. If the discount rate has increased, it means that investors are now demanding a higher return as the price of holding shares. So what is it, better value or higher future returns? I have no idea, but I’m good with either one.
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Temporary horizon. As stocks tumble, investors’ time horizons shrink. Suddenly, all many people can think about is whether stock prices will rise or fall in the coming days, and their best estimate guides their trading decisions.
This is where savvy investors get their edge. It is difficult to outsmart other investors. But we can play a different game, focusing not on next week but on the next 10 years. Does anyone doubt that a globally diversified stock portfolio will be worth more in a decade? When we play the long game, it becomes much easier to know what to do.
This column first appeared on Humble Dollar. It has been republished with permission.