Investors reacted like the sky was falling on Friday. Commentators mostly blamed the -400 point decline in the Dow on heightened probabilities for a September rate hike by Janet Yellen and her fellow Federal Reserve colleagues. Geopolitical concerns over a crazy dictator in North Korea with nuclear weapons were identified as contributing factors to frazzled nerves.
The real question should be, “Are these stories complete noise, or should I pay close attention?” For the vast majority of times, the response to questions like these should be “yes”, the media headlines are mere distractions and you should simply ignore them. During the last rate hike cycle from mid-2004 to mid-2006, guess how many times the Fed raised rates? Seventeen times! And over those 17 rate hikes, stocks managed to respectably rise over 11%.
What can past market crashes teach us about the current one?
So far this cycle, Yellen and the Fed have raised interest rates one time, and the one and only hike was the first increase in a decade. Given all this data, does it really make sense to run in a panic to a bunker or cave? Whether the Fed increases rates by 0.25% during September or Decemberis completely irrelevant.
If we look at the current situation from a slightly different angle, you can quickly realize that making critical investment decisions based on short-term Federal Reserve actions would be foolish. Would you buy or sell a house based solely on this month’s Fed policy? For most, the answer is an emphatic “no”. The same response should hold true for stocks as well. The real reason anyone should consider buying any type of asset, including stocks, is because you believe you are paying a fair or discounted price for a stream of adequate future cash flows (distributions) and/or price appreciation in the asset value over the long-term.
The problem today for many investors is “short-termism.” This is what Jack Gray of Grantham, Mayo, Van Otterloo and Company had to say on the subject, “Excessive short-termism results in permanent destruction of wealth, or at least permanent transfer of wealth.” I couldn’t agree more.
Many people like to speculate or trade stocks like they are gambling in Las Vegas. One day, when the market is up, they buy. And the other day, when the market is down, they sell. However, those same people don’t wildly speculate with short-term decision-making when they buy larger ticket items like a lawn-mower, couch, refrigerator, car, or a house. They rationally buy with the intention of owning for years.
Yes, it’s true appliances, vehicles, and homes have utility characteristics different from other assets, but stocks have unique utility characteristics too. You can’t place leftovers, drive inside, or sit on a stock, but the long-term earnings and dividend growth of a diversified stock portfolio provides plenty of distinctive income and/or retirement utility benefits to a long-term investor.
You don’t have to believe me – just listen to investing greats like Warren Buffett:
“If you aren’t willing to own a stock for ten years, don’t even think about owning it for ten minutes. Put together a portfolio of companies whose aggregate earnings march upward over the years, and so also will the portfolio’s market value.”
The common sense test can also shed some light on the subject. If short-term trading, based on the temperature of headlines, was indeed a lucrative strategy, then the wealthiest traders in the world would be littered all over the Forbes 100 list. There are many reasons that is not the case.
Even though the Volatility Index (aka, “Fear Gauge” – VIX) spiked +40% in a single day, that does not necessarily mean stock investors are out of the woods yet. We saw similar volatility occur last August and during January and June of this year. At the same time, there is no need to purchase a helmet and run to a bunker…the sky is not falling.
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