The winter rally that carried the S&P 500-stock index to post-recession highs last week and a year-to-date gain of around 12 percent is another reminder, if we needed one, of the futility of trying to time the market’s ups and downs.
Suppose the market finishes 2012 with the S&P around 1,400, which is the level it reached last week for the first time since 2008. History would record this as a pretty good year. The double-digit gain would be somewhat better than the market’s long-term average, and significantly better than last year’s flat results. (I am disregarding the dividends that those who actually hold the S&P stocks or mutual funds receive; those dividends would add a percentage point or two to the returns.)
But an investor who bought the index when it reached 1,400 last week would have missed the entire year’s movement. That luckless investor would just break even in this good year scenario. The market will have ups and downs along the way, but in this hypothetical case, the rest of 2012’s results would just be noise.
I have no way to know whether the rest of 2012 will take the market higher, lower or nowhere at all relative to the present moment. And though a lot of people have opinions on the subject, nobody else really knows, either. There are good arguments to be made for each possibility.
The downside risks include all of the negatives we have heard for months and years, including the European debt crisis, American budget deficits and political gridlock, and the risk of another global economic slowdown (possibly triggered, this time, by a downturn in China). There are also some brand-new considerations, such as a fresh spike in energy prices and the prospect that U.S. tax law will revert to its 2001 version - a massive increase for most Americans - if Washington does not act by the end of this year.
The upside arguments are that the American economy in particular is finally gaining some strength; companies are doing a modest amount of hiring; housing prices seem to have reached a floor in many places and are starting to recover in some; and - most importantly - corporate profits are healthy while the price of stocks compared to those profits is low by historic standards. This combination makes additional stock gains quite reasonable in the long run, though unpredictable over shorter periods, such as the remainder of this year.
The market climbed nearly this high, above the 1,360 level, last spring. Then it took a beating last summer, as all the aforementioned downside risks combined to spook investors. By August, when Standard & Poor’s cut its rating on U.S. Treasury debt below AAA, the markets were in a full-blown panic. By autumn the index was below 1,100.
In hindsight, that was a good time to buy stocks, of course. The problem is that nobody buys stocks in hindsight. We all act in the moment, and at any given moment, our hopes, fears and doubts about the future tend to create an emotional stew, which leads many people to procrastinate before finally following the crowd, often at exactly the wrong time. This is why so many people end up buying stocks near the market’s peaks, selling near the lows, then swearing off stocks altogether until, finally, rising markets draw them back in for another round. These are usually the same people who end up complaining that their 401(k)s have become 201(k)s.
It doesn’t have to be this way. A considerable number of thoughtful professionals (including my colleagues here at Palisades Hudson) do everything in their power to take the emotion out of investing in stocks. We counsel clients that stocks are for long-term growth, not for money that you expect to need or to use within the next five to 10 years. With an appropriate long-term focus, short-term market movements are less important. We note that market downturns, which are often frighteningly rapid, don’t matter in the long run - even a downturn as severe as the historic crash of 2008-2009, from which we have now pretty much recovered.
Advisers like us told people the same last summer. I wrote a commentary about buying when there is blood on the streets, not to endorse market timing but to encourage people to overcome the fear that paralyzes long-term investments at the optimal times for making them. In another commentary, I pointed out that the Treasury debt downgrade told us nothing we did not already know about the deteriorating state of U.S. government finances.
Professional advisers have an advantage over other people when it comes to investing: We’re not handling our own money. That makes it easier to take the emotion out of the process in hopes of getting a sounder, more rational long-term result. I was not alone in urging investors to stay calm. The firm of Plante Moran issued a like-minded commentary just before news broke about the S&P downgrade decision on Friday, Aug. 5. Colorado Financial Management provided similar comments on Aug. 8, pointing out the differences between last summer’s financial environment and the global crisis of 2008, and also noting that downturns like the one we saw last summer are not unusual in stock market history. Unfortunately, calm and sound advice is usually drowned out by the scare headlines and screaming heads that fill our screens at such times.
Market timers would probably argue that the solution is simple. Just buy before the market goes up, and sell before it goes down. That’s great, except that nobody can reliably tell when those changes in direction will occur. All of the issues that frightened the markets last summer are still with us. All of the potential that the markets recognize today existed last summer, as well. It was just a matter of time before consumers needed to replace old cars, householders needed to buy or rent housing, and companies needed to add staff to meet customers’ long-deferred demands. The only thing that is fundamentally different now compared to last summer is the headlines.
A financial adviser’s life would be much easier if clients wanted to invest when everyone else panicked. A few do, but most will hold off during scary times like the winter of 2009 and the summer of 2011. They tend to show up at times like this, when the market has risen nicely for a while and the memory of past scares starts to recede. It makes no sense to turn such clients away, because in the long term, economic growth and corporate profits should always lead the markets to new highs - eventually. But first we have to try to keep these clients from bailing on their own long-term strategies and locking in their losses by selling as soon as the next downturn hits.
That’s why I write about topics such as the big panic of just three years ago or the milder scare last summer. I want everyone to remember that as bad as they felt at the time, their only significance today is that they look like great times to have been a buyer.