When facing recessions, stock prices can take a long a long time to decline to its lowest point. When the dot-com bubble burst in mid 2000, it took about 2 and a half years before the S&P 500 bottomed out. Similarly when the housing bubble burst at the end of 2007, it took a year before the S&P 500 reached its bottom in March 2009.
Long periods of slow decline in the stock prices put the convictions of long term investors to the test. When stock prices are rising, there’s enthusiasm all around. But as the trend changes downward you first hear of panic as short term investors rush for the exits. Eventually all the noise will disappear as panic turns into capitulation. No one wants to talk about their portfolio anymore. Short term investors would be nursing their losses.
Why are short term investors looking at losses at this point? They probably bought a hot stock that gave them a quick gain initially. However, their investing horizon is short, probably weeks or months long, which means they probably got in near the top of the stock price. Now that the stock price has tanked, if they haven’t gotten out already, they are probably trying to justify to themselves reasons why they should continue holding onto their unrealised losses. If they sold, then the losses immediately gets realised – and this is a reality that they are not ready to face.
This is the problem with many short term investors that are just starting out – when locking in gains they behave as short term investors, but when facing losses, they behave as long term investors thinking that their unrealised losses will eventually reverse out given enough time.
We are now 4 months into 2022 with a consistent decline in the general US stock market. The main reason this time is the rise of inflation and the consequential raising of the Fed fund rates in an attempt to temper it. Inflation is caused by the restricted supply chains globally whilst the Western countries open up their economies in 2021. The US also exacerbated the situation by massively stocking up inventories in the attempt to smooth out the supply chain issues.
Logically given time, Covid-19 will be behind us and the supply chain problems would in turn lessen. Inflation would then return to normal and there would be no reason to keep a high Fed funds rate. If the US economy enters a recession before the global supply chain problems are resolved, inflation would also be reduced and the Fed funds rate will also go down. I don’t think the Fed funds rate will remain high for long given the amount of debt there is today.
What this means for the long term investor is that eventually stock prices will rise again. No one can tell when that will happen though. But what is possible in my view, is that stock prices will continue their slow decline for a long time before turning around.
As Warren Buffet once joked that when the tide goes out you will find out who has been swimming naked. Only the most durable companies will survive through recessions by their sheer market dominance and strong balance sheets. This slow market decline presents an opportunity to accumulate the shares of these dominant companies.
Perhaps you have had no luck in picking strong companies. That is alright because even most fund managers are unable to beat the S&P 500 index over the long run. Simply drip feed your investments into a plain vanilla S&P 500 index fund. This is a collection of the 500 strongest companies listed in the US stock market.
Nothing in life lasts forever – the good and the bad. Stock market declines will not be forever. There will be a time when things turn around and you want to turn that corner with the best position you can get in the stock market.