Two weeks ago, everyone agreed: It was a second Great Depression, and the DOW was going to 5,000. Only a fool would step in and buy the S&P 500 at 750, everyone said, because it was obviously going to 600. The economy was headed to hell in a handbasket, Q4 earnings were going to be horrendous, and there was nothing that could be done to stop any of it.
But now, of course, with the S&P 500 up 20% from its low, things look a bit different. Specifically, it looks as though the market might already be looking past ghastly Q4 earnings and hideous unemployment and discounting the eventual recovery. Suddenly, the chatter on CNBC has gotten more positive, and it doesn’t seem quite so clear that the DOW is going to 5,000 and the S&P 500 to 600. In fact, it looks as though you might have missed the bottom.
Bummer! So should you buy in now, before the market really runs away?
Welcome to the joys of market timing.
Here’s the big picture: Stocks are still down more than 40% off their highs. They’re about at fair value (900 or so on the S&P 500), which suggests that they’ll deliver average returns over the next 10 years (10%-ish).
Stocks could certainly resume their decline: A bottom around 600 on the S&P 500 would be in keeping with the trough after burst bubbles of similar magnitude. And, presumably, stocks could also run away: With all that liquidity the government’s been creating, inflation could eventually go through the roof.
Over the long haul, though, stocks should deliver an average return.
If we had to bet (which, thankfully, we don’t), we’d bet that the market will resume its decline early next year, when the Obama excitement wears off and it becomes clear that recovery will be a serious slog (and, OK, we admit it: We’re making a small bet that this will happen, by remaining underweight stocks). As long-term investors, we actually hope that’s what happens, because it will give us the opportunity to buy stocks when they are really cheap, not just average. But we’re also not going to risk missing a turn by trying to nail the absolute bottom.
Fund manager John Hussman’s note this week provides some context that makes this behaviour feel better. Specifically, John demonstrates what would happen to our stockholdings if this really is a second Great Depression (which, for now, it’s miles away from):
The point of all this is to discourage investors from abandoning reasonable investment positions with the market already down by nearly 50%. If your asset allocation is well diversified and not aggressive, you are not likely to do yourself a favour by cutting your risk to well-below average levels in response to market losses that have already occurred. Had an investor bought stocks during the Great Depression when they were already 50% off their highs (late 1931), that investor would have suffered a great deal of loss into the 1932 low, but would still have had a gain two years later.