Groundhog Day
Equity investors said goodbye…and good riddance…to the third quarter of 2011 on Friday. After climbing 6% during the first six months of the year, US Large Company stocks plunged 14% from July through September, enough to bring their year to date return down to a negative 9%. Small Company and International stocks have fared even worse on the year, while short term, high quality bonds are still clinging to miniscule year to date gains.
The culprit for the equity markets’ dismal performance during the quarter? Choose your poison. Standard and Poor’s unprecedented downgrade of the US Government’s coveted AAA debt rating, disappointing US and Chinese economic recoveries, Europe’s debt woes, and the potential bankruptcy of a nation whose roots date back 5,000 years are all weighing heavily on the markets. These unprecedented events have combined to allow the single most infamous wealth destroying thought to creep into investors’ psyche: “It is different this time.”
The truth is it is always different this time. Even a cursory examination of recent history reveals no fewer than seven major events which triggered significant equity market declines over the past thirty years: The 2009 Financial Crisis (Dow 6600), September 11th (Dow 7600), 1998 Asian Contagion (Dow 7900), 1994 Jobless Recession (Dow 3700), 1990 Gulf War I (Dow 2600), 1987 Black Friday (Dow 1700), and the 22% Prime Rate Recession of 1980-82 (Dow 800). Amidst the inherent fear, anxiety, and uncertainty of a crisis, investors face three options:
- Sell shares until things “settle down” and convert temporary fluctuations into permanent losses.
- Do nothing and reap the full reward of the inevitable recovery.
- Opportunistically accumulate additional shares at discounted prices.
Fear drives investors toward the first option. Yet as the Dow climbed from 800 to almost 11,000 through wars, recessions, global unrest, and the worst two Bear Markets since the Great Depression, we see how downright ridiculous this strategy would have been…each and every time. Few investors ever fully embrace the undeniable truth that although the catalysts for market declines change, the equity market’s response to them has been beautifully similar. The pattern reads like a book: a new (or perceived) crisis unfolds, fear reigns, the market temporarily declines, and the market resumes its permanent upward march.
It is during times of crisis that successful investors distinguish themselves. We know that, unlike lottery tickets, our shares represent ownership stakes in the earnings and dividends of thousands of great companies: Coca Cola, Apple, Heinz, Nestle, Chevron, Wal-Mart, just to name a few. We know that as the world’s population expands, as technology leads to innovative products and services, and as improved efficiencies allow them to do more with less, great companies earn more money, increase their dividends, and increase in value. Although we can never know exactly how or when a crisis will abide, it is enough for us to know that it most certainly will. Our optimism is not based on faith, but on historical facts.
So we have a choice. We can believe the doomsayers, give in to our fears, look back with regret a year or two from now, and wonder what we possibly could have been thinking. Or we can choose to align ourselves with the only outlook that reconciles with historical facts: the value of the world’s great companies (and consequently, of our portfolios) will oscillate randomly above and below a perpetually rising trend line. We care entirely too much about each and every one of our clients to do anything but choose the latter.
Invest intelligently. Diversify Broadly. Ignore the Noise.
Don Davey
Senior Portfolio Manager
Disciplined Equity Management