Maintaining perspective is a critical element to having success in market. Many of you have seen the chart below from “JP Morgan’s Guide to the Market” as we refer to it often in our meetings and discussions. The bars are the returns for each year, for example the first bar represents the return in 1980 of 26%. The red dot below that bar is an intra year move of -17%. What the chart is depicting, using the year of 1980 as our example, is that the markets return at year end was up 26%, however during that year the market had a -17% swing. So it ended the year up 26%, but sometime during that year it was down 17%. And then you can see every year thereafter. We think this is important because it provides perspective that in any year we will have market swings, some of them dramatic, yet as you can see the market is up the majority of the time year after year.
We also believe the market is primarily driven by 3 factors: Fundamentals, Emotions & Momentum.
These primary factors are what is driving the markets today. The “momentum” is primarily driven by traders and high frequency trading firms. The “emotions” primarily come from individual investors/401k holders etc… And the “fundamentals” are what long term investors use to think through whether they see real value in the markets.
One could wonder how could the market set a new high 6 days ago, and then 6 days later drop 10%. That’s primarily due to the “momentum” traders being over extended and having to shift their positions. Then follow that with the barrage of news flow over the Coronavirus which has fueled a ton of emotions and now the long term investor is sorting through all of this to see if the “fundamentals” are truly going to be affected by all of this, which may impact the value of the companies in the market. All of this has happened in 6 days, thus creating these wild swings to the downside.
What is the underlying value of the market?
That is the problem, that is what every investor is trying to figure out right now and that is what is causing so much volatility. First let’s take our starting point, by many investor standards including our own, the market was at an all-time high and valuations were a bit extended. Then pile in the constant virus news flow, along with the political environment that’s heating up on our TVs and news sources every night. Those two issues by themselves are enough to influence our emotions and thoughts about the future of our economy, the two have them combined just adds even more “fuel to the “emotional” fire” for this week.
So now investors find themselves down a few thousand points from the new high, reviewing the fundamentals of the markets to see where the value is. The issue is how does one evaluate the “unknown?” What happens to the market if the virus spreads to the US in a more rapid rate or what if it is quarantined in the next few months? What happens to our markets if the current President is replaced by a Democratic nominee, and what are their policy changes going to do to the markets? What if the current President remains in office? There are a lot of unknowns right now to factor in.
This is what the market is trying to digest in the midst of a momentum shift by traders and heightened emotions by investors. For some perspective, remember the market hit a new high in October 2018, then dropped 20% by December of 2018, only to set a new high by Q1 of 2019. I am not suggesting that we will follow the same path today, I am suggesting that this is just part of being in the markets. We have had several years with an unusual lack in volatility. 5-7% drops are the norm for the markets, 10% drops happen every year or two and 20% or greater drops, well, as tough as they are to watch, they have been the greatest opportunities to find value in the markets to invest for the long term.
We continue to apply the principles of our investing process, and yes you have all heard them before, they have not changed, because they continue to stand the test of time.