Inconvenience and Opportunity

Published On: September 21, 2021

Written by: Ben Atwater and Matt Malick

In the post-World War II years, volatility in U.S. equity markets has served to push fragile money out of stocks, thereby boosting the returns of those who have stayed invested in the market through periods of stress. Investors who have stayed the course have built meaningful wealth.

Volatility is an inconvenience. It can limit liquidity, it can cause stress, it can lead to poor decisions, and it can reinforce people’s thinking about their worldview. But, if we can navigate the inconvenience, opportunity awaits.

The first and most important opportunity is to remain invested. The second opportunity is to use volatility, if it gets extreme enough, to buy stocks at lower prices.

It is our view that markets are not predictable, nor are “reasons” for market performance generally accurate. Markets are volatile and they follow earnings over long periods of time. Events in between are simply “noise.”

Occam’s razor suggests the simplest explanation is usually the best one. So, for example, given that September is historically the weakest month for the market, we can posit a pullback in September is likely due to seasonal weakness.

But who knows? As we have pointed out more than once before, there is still no consensus on what caused the 1987 stock market crash. The only thing we really know is pullbacks are common, sudden and unpredictable.

We think it’s best to evaluate any pullback we experience by understanding how common these pullbacks are, while also remaining aware that it could get worse.

Over the last 75 years, we have had eighty-four 5% to 10% pullbacks. That’s more than one per year, on average. Therefore, you must consider 5% to 10% pullbacks mere hiccups, until otherwise proven wrong. The average time to recover from these selloffs is one month.

During the post WWII period, we’ve also seen 29 drops over 10% but less than 20%. That is about one every 2.5 years. Still common. While more disconcerting, they are also more of a buying opportunity because many of these drops do not get worse. And the average time to recover is four months.

Only 9 times in the last 75 years has the market fallen between 20% and 40% and even in these cases the average time to recover was only fourteen months.

These statistics argue strongly that buying weakness in stocks is normally wise.

Of course, there have been 3 occasions post-WWII when the market fell more than 40% and, in these cases, the average time to recover is almost five years.

However, even in these cases, if you have a balanced portfolio, and you rebalance it, your time to recover will likely be half that time . . .

And in modern market history, that is a very appealing proposition and a small price to pay, especially given the excellent returns that markets have given equity investors post-WWII.