I recently attended a rather depressing presentation from a very well-known market strategist, who shall remain nameless.
The presentation wasn’t exactly terrible. In essence, it was just a re-hash of all the headlines we’ve become so painfully inundated with of late – the Greek debt crisis, European financial contagion, the stubbornly high levels of U.S. unemployment and consumer debt, the never-ending real estate doldrums, and on and on.
What struck me, though, both throughout the presentation and particularly at its conclusion, was that not once did he put any of this information into any kind of meaningful context.
By context, I mean one thing and one thing only: why should I as an investor care about any of this? What does it mean to me, or more specifically, what can I do to take advantage of it?
The doomsayers and day traders would say all of this means that the world as we know it is clearly coming to an end, and as investors, we should therefore probably diversify our portfolios into an even mix of potable water and firearms. The more realistic investor, on the other hand, will ask a very different question: in the context of everything that’s going on, are investments cheap or expensive?
If investments are expensive, it’s likely a good time to sit on any excess cash you may have, and hold tight until prices come down. But if investments are trading at cheaper prices than their underlying value says they should be, then the serious investor will say great, it’s time to buy more!
So what do the numbers tell us? From a purely numerical standpoint, corporations today are awash in cash, earnings are solid, and stock valuations are the cheapest they’ve ever been relative to interest rates. If you ask me, that all adds up to a pretty great buying opportunity.
But don’t take my word for it. Ever heard of an up-and-coming investor by the name of Warren Buffett? In November 2009, he decided that investments were offering a pretty attractive deal – so attractive, in fact, that he dipped into his cash reserves and dropped $34 billion on a railroad.
Now, I’ve never had the pleasure of buying a $34-billion railroad. But I suspect at least a few months must have passed between the decision to buy and the actual transaction.
If the transaction occurred in November, that means Mr. Buffett must have decided to buy the railroad somewhere around the spring of 2009. Not surprisingly, that just happened to coincide almost perfectly with the absolute bottom of the latest market downturn, at a time when the news analysts were churning out their direst economic predictions.
If smart investors are supposed to be running away when the news is bad, why does the smartest investor on the planet go on a buying binge right when everyone else is frantically burying gold and freeze-dried lasagna in their backyard?
The fact is, despite all the warnings to the contrary, average investors still tend to sell their investments at the worst possible time – when the markets hit bottom – and then buy back in again only after things start to look rosier – namely, once the price of stocks has already shot back up.
This isn’t anecdotal theory or idle conjecture. If you want to see what the average investor is up to, just take a look at the flows in and out of equity mutual funds.
The large equity funds have all recorded net redemptions every year since late 2007. Conversely, looking back a little farther, we can see that those same funds almost always registered a peak in cash flowing in right around the top of every market cycle.
To put it another way, while most investors know they’re supposed to buy low and sell high, in reality, they tend to do the exact opposite!
The silver lining to this self-defeating behaviour is that it gives those few truly long-term investors like Mr. Buffett ample opportunity to step in and scoop up stocks, mutual funds, railroads and just about anything else at rock-bottom valuations.
I know, I know – it’s hard to be rational about a declining stock market. When every network news anchor is warning you that the sky is falling, and it looks like all your hard-earned savings are going straight down the drain, it can feel like the only way to stop the pain is to take what’s left of your money and flee to safety until the storm passes.
But for really savvy investors, declining stock prices are our best friends. If you invest a set amount each month, declining stock prices mean you get more bang (and more shares) for your buck. If you’re holding stocks, declining share prices are a great time to re-invest those dividends in preparation for the inevitable recovery.
And for those who don’t believe there ever will be a recovery, all I can say is, take a look at history. Over the past 200 years, every 20-year period on record has seen the stock market offer annual compounded returns of somewhere between 8% and 11%. It was true through two World Wars, it was true through the Great Depression, and it’s almost certainly true today.
Unfortunately, all good things must come to an end. The bad news won’t last forever, and when it stops, those fire-sale stock prices will jump back up through the ceiling, and our opportunity to use the steady stream of doom to our advantage will have run its course.
Until then, I don’t know about you, but I’m going to keep buying low for as long as I can. Even if I can’t afford my own railroad. At least, not yet.
Alan MacDonald, an Investment Advisor with Richardson GMP Limited, helps investors with over $500,000 of assets make smart decisions about money. Alan is the co-author of "The Copperjar System, Your Blueprint for Financial Fitness" available on Amazon.
All material by Alan MacDonald, Investment Advisor at Richardson GMP Limited. The opinions expressed in this article are the opinions of the author and readers should not assume they reflect the opinions or recommendations of Richardson GMP or its affiliates.
Richardson GMP Limited, Member Canadian Investor Protection Fund. Richardson is a trade-mark of James Richardson & Sons, Limited. GMP is a registered trade-mark of GMP Securities L.P. Both used under license by Richardson GMP Limited.