Chicken Little and the Scary Sky

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Chicken Little and the Scary Sky

by | Jul 13, 2016

Just a few weeks ago, the stock market sunk in chaotic fashion in the wake of the surprise Brexit vote. And to many folks’ surprise, it came back with a vengeance and then some.

When heightened economic uncertainty prompts volatility in the financial markets, many investors think the sky is falling and the bottom will drop out and thus begins the selling stampede.  With these events, the natural emotional response is to panic and sell before the selling gets worse, especially when the market is already near an all-time high.

Unfortunately, this instinct to sell is driven by behavioral biases that have been historically proven to lose money for investors, like buying high and selling low.  In reality, markets tend to overreact to bad news. And it’s during these times that successful investors can take advantage of cheaper prices.   However, the average investor usually is too frightened and stocks seem to be one of the only assets that when they’re on sale as much as 20-30% or more, people are afraid to buy in.  Why is that?  Fear of the unknown and “could the sky really be falling”?  Remember that the real value of a company is not usually reflected in the day-to-day stock price, driven by arbitrary market forces.

“Prices fluctuate more than values — so therein lies opportunity,” Gotham Capital’s Joel Greenblatt once said. “Why do the prices fluctuate so widely when values can’t possibly? I will tell you the answer I have come up with: The answer is I don’t know and I don’t care. We could waste a lot of time about psychology but it always happens and it continues to happen. I just want to take advantage of it.”  This type of thinking is very much applicable to investors in the broad indexes with the underlying fabricated notion that one can “time” the market.  (There are numerous enticing books and tapes available for purchase of course that promote this concept).

In its new quarterly guide to the markets, JPMorgan Asset Management shared a couple of interesting charts putting big market sell-offs into context.  One chart shows the largest market drops from peak to trough in any given year since 1980. The average intra- year drop is 14.2% during a period when annual returns ended up being positive in 27 of 36 years.

Another legendary investor who thought like Greenblatt was Peter Lynch, the long-time manager at Fidelity. “A price drop in a good stock is only a tragedy if you sell at that price and never buy more,” Lynch once said. “To me, a price drop is an opportunity to load up on bargains from among your worst performers and your laggards that show promise.”

 “If you’re not willing to react with equanimity to a market price decline of 50% two or three times a century, you’re not fit to be a common shareholder and you deserve the mediocre results you’re going to get,” Berkshire Hathaway legend Charlie Munger also said.

Speaking of centuries, think of what we’ve seen over the last 100 years or more.  Another chart in JPMorgan’s quarterly guide to the market, shows the S&P 500 going all the way back to 1900, there were many events that seemed hopeless: Two world wars, a depression, a cold war, oil embargos, stagflation, terrorist attacks, 18% inflation, the dot.com bust, you name it and yet in the long-run, they all proved to be buying opportunities.  They were all “new”, had never occurred before, yet the stock market has bounced back from some very scary events.

“In the 20th century, the United States endured two world wars and other traumatic and expensive military conflicts; the Depression; a dozen or so recessions and financial panics; oil shocks; a flu epidemic; and the resignation of a disgraced president,” Warren Buffett noted in a 2008 NY Times op-ed. “Yet the Dow rose from 66 to 11,497.”

For most investors, a balanced strategy of diversification using multiple asset classes is more appropriate and may help ease the pain of volatile market swings. For more information and to obtain copies of these JP Morgan charts, please contact us.
 
 
Opinions expressed in the attached article are those of Joel Greenblatt, Peter Lynch, and Charlie Munger and
are not necessarily those of Raymond James
.
The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the U.S. stock market
 
The information contained in this report does not purport to be a complete description of the securities, markets, or developments referred to in this material. There is no assurance any of the trends mentioned will continue or forecasts will occur. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Diversification and asset allocation do not ensure a profit or protect against a loss. Investing involves risk and you may incur a profit or loss regardless of strategy selected. Past performance does not guarantee future results.

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