 |  |
 | ||||||||||||||||||||||||||||||||||
 |  |  |  |  | ||||||||||||||||||||||||||||||||
| ||||||||||||||||||||||||||||||||||||
 |
| |||||||||||||||||||||||||||||||||||
|
Staying the Course We are now well into a major recession. A recent analysis of stock market returns during previous recessions shows an interesting pattern1. We have had fourteen recessions in the United States since 1926. Typically, there were large stock market declines at the beginning of these recessions followed by rapid gains during the early phases of economic recovery. Surprisingly, from beginning to end of each recession, stocks have averaged a positive return of 0.5%. Given this historical pattern, why wouldn't a prudent investor take her money out of the market at the beginning of a recession and reinvest her assets around the market bottom? The best time to get out of the market is before the onset of a recession. Unfortunately, no one rings a bell when a recession begins. According to the National Bureau of Economic Research, the current recession started in December 2007. However, they did not specify this starting point until almost 12 months later in December 2008. By the time most people feel an urge to flee the market during an economic downturn, large losses have already occurred. To exit the market at this point only serves to lock in these losses. While you can avoid further losses by selling your stocks after a recession has begun, there is an opportunity cost from potential missed returns. Historically, the market has rebounded strongly during the first three months after an economic nadir, with positive returns averaging 4.3% per month. Recessions have lasted anywhere from 6 to 43 months, so timing the economic rebound is difficult. By waiting for signs of economic recovery, you are likely to miss the high returns that occur at the onset of recovery. Missing even a small number of good days can have a deleterious effect on long-term returns. For example, if you missed the best 25 days in the market over the past 20 years, your returns would be cut by more than 50%. Last month, the Dow Jones Industrial Average gained 546 points, or almost 8%. Were these strong returns an indication of economic recovery or just a temporary bear market bounce? Any answer to that question is a speculative attempt to predict the future. Despite the positive returns in March, the Dow was down over 13% for the first three months of the year, the worst first quarter since 1939. Daily price movements are like white noise that obscure our ability to perceive whether we're in an up market or a down market. If you can't tell what part of the cycle we're in, how can you time a market turnaround? We all have hunches, but heaven forbid we should make investment decisions based on them. Even in the worst of times, the fundamental principles of finance still offer our best guidance. What gets us through these periods is the knowledge that a low cost, disciplined and diversified approach offers the best probability for long-term financial success. Abandoning the market during difficult times is a risky proposition. Renowned investor Shelby Davis put it best when he said, "You make most of your money in a bear market. You just don't realize it at the time." 1Marlena Lee, PhD. Stock returns over business and market cycles. Dimensional Fund Advisors, March 2009 Please do not hesitate to contact me if you have any questions or comments. Jeffrey J. Brown, MD CFA Recommended Reading for Investors | ||||||||||||||||||||||||||||||||||||
©2001-2010 Shearwater Capital LLC. All rights reserved. | ||||||||||||||||||||||||||||||||||||
