The market has just handed us the first correction since March 2009, the beginning of the rally that carried stocks up 80% before the recent drop. Declines such as this one are unsettling for investors, particularly with the memory of 2008 and early 2009 still fresh. However, corrections are to be expected during a recovery and are not reasons to depart from a sound, long-term investment strategy.
After a 14-month upward march without a correction (defined as a decline of 10% or more), the market was due for one. The primary catalyst for global markets’ fall is the Greek debt crisis and fears of a spillover into other European Union countries. Adding to investors’ nervousness are efforts by the Chinese and other developing nations’ governments to curb economic growth to ward off inflation, geopolitical tensions, and concerns over the impact of these issues on the global economic recovery that is underway.
A recent analysis from Fidelity Investments titled “Stock Market Corrections: Unsettling But Not Unusual” (click here for the full report) points out that the average time before a correction during a bull market is 17 months, so the market is slightly early this time compared to the other bull runs since 1928. Still, this bull market was due for a breather, having risen 80% before correcting, compared to an average gain of 57% in similar historical periods. Fidelity also notes that the global economy has improved dramatically since early 2009, reducing the odds of slipping back into recession.
Another article that caught our attention over the past few days came from The New York Times (click here to read “Resisting the Urge to Sell Low”). As noted in this article, most investors historically would have achieved better returns had they not tried to time the market. According to a study cited, the average investor over the past 20 years realized returns of 3.2% per year, much lower than the S&P 500 index’s return of 8.2% per year over the period. Selling during pullbacks, most likely emotional reactions to the market’s swings, accounted for much of the difference. There is no compelling reason to believe that things will be different this time around. Locking in losses now and hoping to reenter the market at the right moment is likely to hurt, rather than help, investors’ returns.
These are but a small sample of the commentary expressing optimism about the markets and supporting the strategy of staying the course during conditions similar to today’s. We are also aware of the arguments being made by more bearish market observers, and we try to incorporate some of the ideas expressed by them in our approach. For example, we think the best opportunities now lie in large, well-capitalized, multinational corporations with a strong presence both in the United States and abroad, particularly in emerging markets, and healthy cash flows that support rising dividend payments to shareholders.
Finally, it is important to keep in mind that the preponderance of data points to continued recovery in the global economy. As the economy rebounds, corporations that have aggressively cut costs and positioned themselves to take advantage of renewed opportunities should see more quarters of impressive revenue and earnings growth, supporting further market gains.
We believed that stocks were fairly valued when the market reached its recent high last month, and we think the stock market is now modestly undervalued. Yields on stocks are attractive relative to those on Treasurys, and the earnings yield on the S&P 500 index (earnings/price) is more than twice the yield of the 10-year Treasury. As a result, we intend to stick with the securities we own and are looking for more opportunities to invest in the wake of the selloff.