From Pacific Capital Associates.
It is often noted that in the long-run, stocks are the best asset to own. It has also been noted that “in the long-run we are all dead.” So the question becomes how long an investor must wait for that attractive long-term performance to be realized. If one is not careful, it could be a long time.
For an understanding of why this is, consider the following table which shows that at least one serious stock market correction has occurred in every 10 year period since the 1920s:
Source: Investech Research
Consider also that many investors ride down the bulk of these vicious declines only to sell near the lows because they can’t stand the idea of losing any more. Next, many investors miss the ensuing rally and then feel that their hands are tied because they have missed the rally and it’s too late to buy back in. This pattern has been repeated time and again and explains how many studies have shown that the typical investor greatly underperforms the average market returns over time.
It is easy to understand this typical investor behavior, but we must know that it will not achieve satisfactory and timely results. Investing genius Warren Buffet famously wrote, “ be fearful when others are greedy and to be greedy only when others are fearful." This is easier said than done. When it seems like everyone else is throwing caution to the wind and driving prices ever higher, it is frustrating not to be fully invested. Such an approach requires patience and discipline. One must be willing to give up potential gains by reducing market exposure during times when the markets are rising. Similarly, it requires the fortitude to invest when markets are going down and others believe that there is little hope. We believe that an investment approach based upon such discipline has a greater chance of minimizing the downside and maximizing the upside of our investments over time.
When risky market conditions prevail, it’s more important than ever to pay attention to major economic trends, to be diligent about seeking investments with strong long-term fundamentals, and above all to stay cautious. It seems like common sense to state that the top of the market is the worst time to be fully invested, but that topping moment is the point at which the most people have bought in and are most optimistic and least concerned with risk. Of course it is also the point at which the next moves are down. Interestingly, as the top nears, there are always analysts explaining why such price increases are justified, but we find that their reasons have a lot more to do with hype and wishful thinking as to why “it is different this time” than they do with the fundamentals.
At this point we will continue to look for investment opportunities in specific areas of the US market as well as areas outside the US market. After experiencing very favorable returns over the last 4 years, at this point, if the market continues to make gains, we will have to be content with a comparatively smaller return. However, we suspect that any market gains beyond this point will most likely be given back during the next downside correction. As long-term investors, that’s not the kind of gain we’re interested in.
When the next downturn is upon us, we will stay focused on this additional bit of wisdom from Warren Buffett: "Fear is the foe of the faddist, but the friend of the fundamentalist." In other words, market corrections and environments of fear and risk-aversion are devastating to trend-chasing speculators, but to long-term fundamental investors they need not be so harmful. The best approach is to minimize exposure to such downturns, to endure them, and to be ready to capitalize on them as they pave the way for better risk-adjusted opportunities ahead.
During times such as these, our strategy is to be disciplined and to focus on the time-tested measures of value, risk, and reward. The “father of value investing” Benjamin Graham famously wrote, "In the short run, the market is a voting machine but in the long run, it is a weighing machine." This is to say that on a shorter term basis, the popular stocks or sectors can rule the day, but over a longer term, it is the stocks that are supported by sound fundamentals that provide the best results. We agree