If there is one thing I know about the stock market, it’s that it is confusing…
There’s a lot to unpack when you are analyzing the stock market. Staring at price-to-earnings ratios, technical analysis, bollinger bands, and moving averages can leave your head spinning. But more importantly, all of that analysis can actually do more harm than good for the individual investor. Getting bogged down in day-to-day performance can cloud bigger-picture investing trends.
It’s a simple case of not seeing the forest through the trees…
I’m more a fan of the Occam’s Razor theory: the simplest explanation is usually the correct one. In other words, if it walks like a duck and talks like a duck, a head-and-shoulders-pattern isn’t going to convince me that it’s a beautiful woman. It’s probably a duck…
That’s why I like charts like the one featured below, from John Hussman, PhD from Hussman Funds:
Woo-hoo! Let’s all go get ice cream and count our money! Our troubles are over!
I have to laugh to keep from crying…
I find charts like this to be the best way to look at historical events like “the great recession” that we’re living through right now. I dare you to take a look at that chart and tell me that everything is fine, the stock market is going to keep hitting new highs, and we all have nothing to worry about.
In fact, as Hussman suggests, there is nothing further from the truth:
I have again become no fun at all, largely because of a combination of high confidence, lopsided bullishness, overvaluation, and an overbought multi-year advance. There’s no question that the absence of consequences – to date – has led investors to believe that those consequences simply will not emerge. Once the consequences arrive, the preceding bubble seems obvious, but it’s a regularity of history that speculative episodes are only completely clear in hindsight.
…
History teaches clear lessons about how this episode will end – namely with a decline that wipes out years and years of prior market returns. The fact that few investors – in aggregate – will get out is simply a matter of arithmetic and equilibrium. The best that investors can hope for is that someone else will be found to hold the bag, but that requires success at what I’ll call the Exit Rule for Bubbles: you only get out if you panic before everyone else does. Look at it as a game of musical chairs with a progressively contracting number of greater fools.
So, if the coming crash seems all but an inevitability, why wait around for the music to stop before you grab a chair? Prepare yourself for it, because if you don’t, you’ll be standing without a chair for years. Like Jim Rogers says, “Bottoms in the investment world don’t end with four-year lows; they end with 10- or 15-year lows.”
So let’s take a look at what some of history’s brightest investment minds do at times like this…
First, a quick history lesson…
On Oct. 19, 1987, the stock market suffered what we now call Black Monday. The Dow Jones Industrial Average lost 508 points — almost a quarter of its value — in one day. That is the worst single-session percentage drop in history.
Most people were running for the hills. Some analysts thought this would be the death of the stock market for years to come. Long story short, ordinary investors were selling off their portfolios at massive losses.
But one visionary knew the Baron Rothschild quote, “Buy when there is blood in the streets… even if it’s your own.”
John Templeton — billionaire founder of the famous Templeton Funds — played it cool. He didn’t sell… he bought like crazy. Here’s how Templeton’s Black Monday unfolded…
You see, Templeton was a man of habit, and on Black Monday, he left his office around noon for his daily practice of exercise, lunch, and studying. When he returned to the office, there was a full-blown panic going on.
When told of the massive market crash, Templeton quietly pondered the moment and, according to one colleague, said, “The bad news is we’re in a bear market. The good news is it’s almost over. Let’s find stocks to buy.”
It was that simple. That’s because he stuck to his 16 rules of investing. Rule number 10 bears repeating here:
RULE 10: Don’t Panic
Sometimes you won’t have sold when everyone else is buying, and you’ll be caught in a market crash such as we had in 1987. There you are, facing a 15% loss in a single day. Maybe more.
Don’t rush to sell the next day. The time to sell is before the crash, not after. Instead, study your portfolio. If you didn’t own these stocks now, would you buy them after the market crash? Chances are you would. So the only reason to sell them is to buy other, more attractive stocks. If you can’t find more attractive stocks, hold on to what you have.
Templeton believed in buying solid stocks at the time of “maximum pessimism.” That way, you can lock in discounted stocks you would have liked to buy anyway but thought they were too expensive. It sounds incredibly simple… but it’s hard to swallow when all you see is panic and chaos. You just have to stick to your guns and think long term. It also helps to avoid the screaming headlines in the Wall Street Journal and the exploding heads on cable television.
Another famed investor — Warren Buffett — is no stranger to crash investing either. Here’s how the Oracle played the 1987 crash…
After the 1987 crash, instead of liquidating his positions at a huge loss, Buffett did what he does best: value investing.
He started loading up on Coca-Cola shares. Here’s a recap from a Buffett biography:
In 1988, he started buying up Coca-Cola stock like an addict. His old neighbor, now the President of Coca-Cola, noticed someone was loading up on shares and became concerned. After researching the transactions, he noticed the trades were being placed from the Midwest. He immediately thought of Buffett, whom he called. Warren confessed to being the culprit and requested they don’t speak of it until he was legally required to disclose his holdings at the 5% threshold. Within a few months, Berkshire owned 7% of the company, or $1.02 billion dollars worth of stock. Within three years, Buffett’s Coca-Cola stock would be more than the entire value of Berkshire when he made the investment.
You don’t make returns like that by buying at the top. Crisis investing is one true mark of a seasoned, successful investor. And we may be looking at a generational opportunity here. Don’t be a victim.
Don’t panic… profit.
Say you were an ordinary investor on Black Monday. If you bought into the broad market immediately following the bloodbath, a mere five years later, you would have reaped an annual gain of 14.5%.
Compare that to the average five-year gain of 9.7% between 1926 and 1987.
If you held for 10 years, that same portfolio would have jumped to 17.2% compared to the stagnant growth of 9.9% in the decades between 1926 and 1987. You could set yourself up for life with a few safe and easy moves. I’m not talking wild speculation here: After 1987, large-cap stock prices rose 12% in 1988 and about 27% in 1989.
You can easily replicate these results once this market finally comes to its senses. So don’t keep walking around in circles until the music stops. Pick yourself out a nice seat, and comfortably prepare to load up while other investors run frantically around trying to find somewhere, anywhere to sit…
