San Juan Mountains

San Juan Mountains
San Juan Mountains: Grenadier Range

Thursday, August 27, 2015

The Market's Machinations Are Meaningless

I made my first investment into the stock market in 1985.  I had earned a little bit of extra money by agreeing to clean an enormous church building by myself over the Christmas vacation week.  My employer paid me a premium for my efforts and after buying Christmas presents for family and friends I had some money left over to invest.  I don't remember what my first investment was but I do remember what happened to it less than two years later.  In one day, in October of 1987, my investment lost over 25% of its value.  That was my introduction to what are known as stock market corrections.
Technically a correction is any stock market decline within a one year period of time greater than 10%.  Pundits will call strong corrections of greater than 20% bear markets.  I adopt those generally accepted definitions while recognizing that any significant decline in stocks is a down market in my mind.  The activities in the stock market this past week motivated me to look at what the stock market, as measured by the S & P 500, has done throughout my investing career.  Here is what I found in regards to down markets:
  • 1987   -33.5%
  • 1990   -19.9%
  • 1994     -8.9%
  • 1997     -9.6%
  • 1998   -19.3%
  • 2001   -49.1%
  • 2003   -14.7%
  • 2004     -8.2%
  • 2008   -56.8%
  • 2011   -19.4%
  • 2011     -9.8% 
  • 2012     -9.9%
  • 2012     -8.4%
  • 2015   -12.2%
The only genuine bear markets in that list of 14 down markets were the tech bubble burst of 2000-2002 and the Great Recession of 2008-2009.  The tech bubble burst was a classic case of irrational exuberance wedded to a total lack of understanding about economic fundamentals leading to a maniacal desire for a single class of investment.  Centuries ago it was the Dutch tulip bulb mania.  At the turn of the millennium it was a powerful belief that technology stocks would never decline in value, even if they never managed to show a profit and sported P/E ratios of infinity.  Both manias came to a sorrowful end for those left holding the bag when things collapsed.
The Great Recession was entirely the product of the stupid and destructive policies of the government of the Socialist Democracy of Amerika.  I have posted at least 10 articles to this blog describing, in detail, how it came about.  I will not be discussing it again here today.
What I will be discussing here today is the nature of the 12 other market downdrafts that have taken place during my investing career.  Those 12 downdrafts technically constitute corrections.  Here are some facts about corrections in general.  According to this website: 

* Since the end of World War II (1945), there have been 27 corrections of 10% or more, versus only 12 full-blown bear markets (with losses of 20% +).
* This equates to one correction roughly every 20 months, according to Dow Jones index maven John Prestbo, who points out that this average does not mean they’re evenly spaced out. 25% of these corrections over the last 66 years occurred during the 1970’s (the Golden Age of Market Timers), another 20% occurred during the secular bear market of 2000-2010.
* The average decline during these 27 episodes has been 13.3% and they’ve taken an average of 71 days to play out (just over three months).
* From the beginning of the last secular bull market in 1982 through the 1987 crash, there was just one correction of 10% or more. Between the Crash of 1987 and the secular bull market’s peak in March 2000, there were just two corrections, according to Ed Yardeni. This means that secular bull markets can run for a long time without a lot of drama.
* Since the stock market’s bottom in March of 2009, there have been only 3 corrections: In the spring of 2010 the S&P 500 began a 69-day drop of roughly 16%. The widely referenced summer correction of 2011 lasted for about 154 days and almost became a bear market. The correction during the spring of 2012 set up one of the greatest rallies of all time, although it was barely a real correction, sporting a peak-to-trough drop of just 9.9% in just under 60 days.
* The most recent correction took place in 2011, between the end of April into the end of September. The Dow dropped roughly 16%. 
* Bull market rallies in between corrections – and there have been 58 in the post-war period – tend to run for an average of 221 trading days before being interrupted and gaining an average of 32%. By this standard, we are way overdue for a correction.
Here are some of my observations about the most recent correction: 
  • The current correction (last week through yesterday) took place 1162 days after the past correction.  That period of time was over five times longer than the average period of time between corrections. 
  • The current correction took place after the stock market had risen 66.5% from its previous correction.
  • The current correction was long overdue.
  • The current bull market, starting in March, 2009, is 6.5 years old and has caused the stock market to rise by 276%.  Those investors who were afraid of stock market corrections have missed a lot of total return by fearfully remaining on the sidelines until things calm down.  Things never calm down.
There are several other facts about corrections that need to be mentioned.  All of the information presented  above, with the exception of my comment about "fearful" investors,  is from various sources and contains nothing but statistical analysis of down markets.  My observations about down markets are of a more subjective nature.  Without any further ado, here are the Welshman's observations about stock market corrections:
  • Stock market corrections are always short and steep.  They catch investors by surprise and create a tremendous amount of panic, especially among investors with little or no experience in the stock market.
  • Stock market corrections cause the pitch and timber of stock market media commentators to rise by several levels as they report the daily performance of the stock market.   One commentator I see on CNBC becomes downright shrill when the market corrects.  
  • Whenever the stock market drops will have a photograph of sad looking traders on the floor of the NYSE on the top of its webpage.  Conversely, when the stock market rises they will post a photograph of smiling traders on top the webpage.
  • Whenever the stock market corrects various media outlets will have special reports about the correction, all of which will contain experts explaining how and why the market is correcting.  None of those reports will come even remotely close to the truth.
  • When the stock market goes into a steep correction all perma-bears (forecasters who permanently predict a down market) will immediately say, "I told you so."  Conversely, when the market quickly goes back to its previous high the perma-bears will have all gone into hibernation.
  • Dozens of reasons will be given for why the world is coming to an end when the stock market corrects.  This time it was Greece, the Fed, the National Debt, the "crisis" in China, economic woes in Europe and ISIS.  None of the stated reasons for the decline have anything to do with it.
  • Here is the truth about corrections:  They are unpredictable.  They are not based upon any objective economic or political reality.  They are caused by groups of day traders panicking together, which leads to more panic, which leads to a correction.  Shortly after the lemming-like day traders realize what they have done they become optimistic about the market and they start buying.  Other day traders start buying and 71 days later we are back where we started.  
  • A general corollary to the General Rule stated in the paragraph above is that the sharper the correction, the sharper the recovery.  Most important of all, never forget that the machinations of the stock market are usually meaningless.  Buy quality stocks and stock funds and hold them for the long term.  You will thank me for that advice some day, if you follow it.

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