For most investors 2018 was a year to forget and from peak to trough, the FTSE All-Share index lost about 16% of its starting value.
For many this was too much to take and several subscribers informed me of their decision to exit the stock market.
That may have been the right decision for them, but since the end of 2018 the market has done what it usually does after corrections and bear markets; it’s rebounded strongly.
For example, the FTSE All-Share is up more than 10% in the first quarter of 2019 alone, and is now only five percent or so below its previous all-time high.
This is normal.
Markets collapse and then they recover.
What matters is not the events, but your response to them.
And your response determines whether you’re thinking like a long-term investor or a short-term speculator:
- Speculators are focused on short-term prices and they sell when prices are falling
- Investors are focused on long-term value and they buy when prices are falling
This constant push and pull between those who are focused on short-term prices and those who are focused on long-term values is what makes the market very efficient, but it’s also what makes the market very volatile.
Another way to think about this is in terms of patience.
Many (but not all) investors who sell during corrections and are impatient.
They expect to see good results year-in and year-out, or even month-in and month-out.
If prices decline for a few weeks or months then they’ll sell up and move on to a new investment which they hope will always go up and never go down.
No such equity investment exists, so in reality the impatient investor ends up buying at the top when everything’s going up and selling at the bottom when everything’s going down.
Patient investors sees things differently.
They know the stock market can suffer short-term declines and they don’t expect to make money every single year.
They also know the stock market is very likely to perform well over the long-term, and if they’re patient during declines then the market should eventually reward that patience.
“The stock market is a device for transferring money from the impatient to the patient.” – Warren Buffett
For me it was painful to see the gains I had made since 2017 wiped out and turned into losses although I held my positions as it made no sense to sell at a loss especially given there wasn’t a terribly strong rationality for the sell-off.
Im sure theres still alot of people out there feeling the sting from that sell-off. Theres still alot of negative sentiment out there and its not too hard to find someone who thinks this run-up is about to implode at any second and the “bear market” is about to resume.
Ive heard alot of people also say you cant and shouldnt try to time the market, but that sell-off has taught me that theres just no point buying at the highs as the risk:reward ratio is unknown. atleast if I buy a dip ive got an idea of how high the market could go and how much downside is possible.
Very sharp market sell-offs make people become demoralized for life about investing.
That approach of investing here and there is for a speculator, not for an investor.
Investors are a calm beast, they look at the market which offers them a 13% per annum return on capital employed, and wait, and wait, until the earnings get reinvested (either by the company, or by investor, if paid as dividends) to generate more earnings at 13% per annum in the same company or elsewhere. Apart from that, as Terry Smith says, you do nothing. It is the long and uncomfortable waiting that gives return to the patient investor.
If for example, you choose, as Terry Smith does, to invest only in companies with a 20%+ ROCE and high barriers to entry, then the relative price you pay now has even less relevance.
As Warren Buffet explained on Sunday: “The decision to buy Amazon’s stock was just as much based on value investing principles as a decision to buy a statistically cheap stock. Value investing is about estimating and valuing future cash flows, not about how low a Price to Book or a Price to Earnings ratio is for a stock.”
I think we are caught in all sorts of tangles when investing, missing what it is important.
Investing is a long term game based on compounding of reinvested earnings;
To get ahead in this game, you need to invest in companies with high return of capital and high barriers of entry – they compound slightly faster;
Apart from this, everything else is secondary.
The last principle is ‘do nothing’ and wait.
Hi Kindke
Unfortunately it’s very difficult to get around the uncomfortable feelings that most people feel when the market falls sharply.
In fact, that’s precisely why the market can fall to such an extent: Some people see the decline, they sell, and that pushes prices lower, so more people sell, so prices go lower, and so on. It doesn’t go to zero because at some point people buying the dip (or buying on valuation grounds) outweigh the nervous sellers, but that doesn’t make it any less unpleasant.
It’s something you just have to get used to. Once you’ve seen the market sell off and then recover ten times over, the declines get a little less uncomfortable. Also, focusing on companies rather than prices can help. If you look at company updates (quarterly reports, etc) during declines, you’ll see that not much actually happens, so the sell-off is usually entirely driven by market-focused sentiment, rather than what’s actually going on with the underlying companies.
Also, Eugen’s reply makes several good points about focusing on companies and the long-term. I don’t necessarily agree that you have to invest in ‘quality’ companies to get a good return, but focusing on companies rather than prices during declines is definitely good advice.
The market can never go to zero, unless a revolutionary government abolishes the stock market, or there’s an asteroid impact, or something of that magnitude. If stocks went low enough, average earnings per share would be over 100% per year and dividends might be, say, 70% per year. It would be crazy not to invest long before shares got that low.
What if FTSE 100 shares were half their present price? Earnings per share would be roughly 12% and dividends would be roughly 8.5%. Surely the consensus would soon be that this represented a once in a lifetime bargain and shares would rebound? Investors would enjoy the capital gain of the rebound on top of the huge earning per share/ dividends.
Normally share prices are not near such extremes and they seem to follow random walks. The stock market fall in 2018 wasn’t “correcting” anything. It just fell for no particular reason, then it went back up again for no particular reason.
I use Robert Shiller’s CAPE measure (as recommended on this excellent website of John Kingham’s) to decide what is a fair price for shares. I decide how many I personally feel like holding, knowing that they can still fall a very long way. If shares then fall, I’m actually happy because I can buy more and if they fall further I buy still more (but not too many). I’m confident that prices will rebound, on which I’ll sell my extra purchases. If prices rise above what I think fair, I sell some. The hard parts are deciding honestly how risk averse one is and resisting the temptation to do extra trades on a whim.
People who have felt stung by the modest falls in 2018 and who have left the market as a result, either did not understand how far the market can move or did not understand their own risk aversion. Be prepared for much bigger falls and much bigger rises.
Hi Gilbert, well said.
“The stock market fall in 2018 wasn’t ‘correcting’ anything”
I agree with this. I was using the term ‘correction’ as it’s a common description of a decline which is more than 10% but less than 20% (with 20% being the default definition of a bear market). For me, correction applies when the market is correcting an excessive degree of overvaluation, or even undervaluation, but that wasn’t the case here. Valuations were still reasonable at the end of 2018 and they were just slightly more reasonable after the decline.
And as you say, for long-term investors a market decline is almost always a good thing. The only time it isn’t is when you’re looking to sell everything (for whatever reason), but if you’re looking to sell everything you should probably get out gradually over a period of several years rather than in one go.
As a financial advisor, I always say that we are in the business of managing people, not assets. The behaviour of people is their best enemy.
There is an education process that we follow with new investors. First and foremost, and we repeat this every time, is that capitalism works.
I also explain that if capitalism stops working, a cash or bond investors won’t be safer. In fact, due to the Governments having so much debt and promises accrued with no provisions (State pensions, unfunded occupational pensions (NHS, Civil Services, Teachers’ etc), healthcare promises etc), their only chance is that capitalism keeps working.
I would say that Governments and even Central Banks are even more incentivised to keep capitalism working.
Quality investing: if you look through your portfolio from 2011 when you started this website, most likely that the companies you have not sold over the entire period are something like Diageo or Unilever, two quality companies. That says something.
For me, the longest term holding I sold in October and December last year was BAT, having purchased the initial shares in 2001. That meant a 17 years timescale, in which I did nothing (just purchased a few more here and there).
I have learned one thing for sure in the stock market one needs to be patient if one wants to see substantial growth after investment. Last year I have seen down and losses on some of the stocks in which I invested. But yes with the end of 2018 and the beginning of 2019 we have seen growth in stock markets.
Now I have invested in Lithium stocks, blue-chip stocks, trending small-cap stocks, different penny stocks as I feel these are some of the trendings.