Stock Market Control
by William Smead, Smead Capital Management
We saw the chart below in a recent Marketwatch.com column from Mark Hulbert. It shows the likelihood of the stock market going up or down in the next year, based on how it did the prior year:
This got us thinking about what you can and can’t control in the U.S. stock market. After all, the reason that stocks outperform other liquid asset classes over long stretches of time is the uncertainty and variability of returns. Here is a short list of things which can’t be controlled in the U.S. stock market:
1. Stock market results
The chart shows that there is a one in three chance that stocks will drop each year regardless of whatever happened the prior year. We don’t think investors should buy or own common stocks if they feel emotionally ill-equipped to withstand a losing year.
2. Stock Market Volatility
Even in good years, stocks can swing wildly from week to week and month to month. The average year sees a peak to trough decline of 10%, and we have seen a 20% or greater decline about once every five years on average. Twice in the last 16 years we saw the S&P 500 Index decline by more than 30%. Granted, that is an unusual occurrence, since there have been only five such declines since 1940. We remember telling common stock investors near the bottom of the stock market in March of 2009 that it would likely take about four years to get their portfolio value back to where it was before the decline in 2008-09. Those courageous and patient investors have been well rewarded by the bull market since then.
An owner of common stocks should expect gyrations as part of the price of admission and use holding periods which allow for recovery and success. The wise investor seeks to use wide, sharp and emotional price swings in their favor.
3. Stock Market Unpredictability
I am approaching my 36th year participating in the U.S. stock market and can say that nobody has proven any consistent ability to predict price moves in the indexes. I’ve read the prognostications of Joe Granville, Stan Weinstein, Marty Zweig, Comstock Partners, Robert Prechter, George Gilder, Nouriel Roubini, Meredith Whitney and numerous other very smart people in my career. The one thing they have in common is they attracted a large following after being very right on a major stock market prediction. However, doing so consistently is a bit like trying to find the pot of gold at the end of the rainbow.
We recently read the musings of a highly-respected asset-allocation firm about their seven-year predictions of asset class returns. Their prediction for the U.S. stock market is extremely negative, which would scare a normal observer and could very well end up being valid. However, we have been reading their predictions for the last ten years and have seen their consistent pessimism for U.S. stocks. We also remember their optimism about emerging markets and commodities. Surely, these predictions from the last five years must have cost someone who followed their advice some serious money.
4. Relative Performance
A study of the best stock picking disciplines of the last 60 years (Buffett, Neff, Templeton, Lynch and Carret) showed that they underperformed the S&P 500 Index 35% of the calendar years during their long and illustrious track records. We expect to be subject to those statistics at best and have very little control over which years we get beat by the index. Our goal is to beat the stock market over ten and twenty-year time periods and we believe those results would be unattainable if you try and smooth that truth.
Things We Seek to Control
We’re not about being glum or dour. We certainly believe there are things that investors can control. We’ve outlined three key tenets to consider when investing in common stocks.