The hot topic at the moment is of course whether or not the market has bottomed. Let me say right at the outset that I have no idea. But then again, I don’t really care.
To demonstrate why I hold this view, I will establish a list of maxims that I consider to be self evident (you may or may not agree), and I will use these to form the basis of my argument.
- The world will not end. Some companies will go bankrupt, economies will slow, earnings will drop, but eventually things will recover. If history is any guide, the economic difficulties are unlikely to last for more than a few years. (If the world does end, your portfolio will be the least of your worries!).
- We are much closer to the bottom than the top. In Australia, the market is 41% below its all time high, while in the US the Dow is around 35% from the top. The biggest correction we have seen for the Dow in the modern era was a drop of 45% in the mid 70’s. The average bear market decline since the 60’s is around 30%.
- A bottom can only be defined in hindsight. By the time we can be confident that the market has bottomed, we would have well and truly passed it. Moreover, we would have missed out on substantial gains along the way.
- Picking bottoms is notoriously difficult. Consider this: The biggest financial institutions in the world are extremely well financed and are able to employ the best and brightest minds in the industry. These experts, with a wealth of training and experience, the best data and systems money can buy, immense market influence and unparalleled access to corporate networks, have difficulty in making consistently correct predictions. You only have to go back to earlier this year, when most of the experts were calling for oil to hit $200/barrel, and parity between the greenback and Aussie dollar. No one can predict the future accurately and consistently.
- You don’t have to pick the exact bottom to make great returns. You only need to get close to the bottom. For example, just prior to the stock market crash of ‘87, BHP was trading at around $4 per share. However following the crash, shares proceeded to lose 45% of their value, and hit a post crash low of around $2.20 per share. Do you think you would have needed to pick the exact bottom to do well? Let’s say that you missed the bottom by a couple of months, and decided to buy some stock the day after the crash in the mistaken belief that the market would immediately bounce. Had you done so, you would have picked up shares at around $2.96 each – and would have watched in horror as you lost 25% of your investment over the next few months. But so what? You would have regained ALL of your losses within 6 months, and within 2 years you would have made a capital return of over 35%. It’s also very doubtful that today you would be worrying whether you got shares at $2.96 or $2.20 - either way you are doing extremely well! (As I write this shares are trading at $28.60 – after falling from a high of around $50. Since the ’87 crash, you would have received around $9.17 per share in dividends)
If you agree with these maxims, then it is difficult to escape the conclusion that picking the bottom really doesn’t matter too much. From a pragmatic standpoint, all you need to do is buy as many good quality stocks as you can and sit tight. Sure, it may take a while for you to see any reasonable gains, and you might even have to wear some nasty paper losses along the way – but you can be confident that when you look at your portfolio in 2018 you will be extremely happy with your returns. When Macquarie Bank is sitting at $200 per share, will you care whether you bought in at $26 or $32??
I know that most readers will be more focused on trading rather than investing, and that the idea of waiting 10 years to see an attractive return is unfathomable. But this is where we need to weigh up two alternatives. On one hand we have a near certainty of making solid returns over the long term. On the other, there is the far less certain (but much more attractive) potential of making great returns in the short term.
What choice you take will depend on your own risk tolerance, but why should we have to choose between these two alternatives? Surely it would make sense to do both. In essence long term investing is about wealth creation, while trading is about income generation. In my opinion, the best strategy is to dedicate a portion of your capital to each, say 20% towards trading and the rest to investing (although this is up to you. The more successful traders could allocate a higher proportion to trading).
That way you can be confident that you are building real wealth over time, while still having the opportunity to make a quick dollar or two along the way. If you are a successful trader, you will find yourself with an increased income, and will have more capital to commit to your long term portfolio. If you have a run of bad luck, well at least you have only lost a small portion of your capital.
So in conclusion, be practical, be reasonable and most of all be realistic. The timing and position of the market bottom is merely a distraction from the fact that good quality stocks are currently trading at a huge discount. This is an aberration that won’t last long…
Make the markets work for you