Is there any hope?
The point of this article is to give a no-BS, numerical reason why you should keep calm and carry on. At The Buylyst, we believe in long-term returns driven by our worldview and fundamental analysis. But occasionally, we look at “market-wide” numbers to put things in perspective.
This recent one-week market rout has been painful to watch. The magnitude is big, but the speed has been nauseating. The worst thing to do right now would be to time the market, panic-sell, or panic-buy. The Coronavirus can create problems for companies and stocks. It will, to some extent. But we don’t know the extent. And investing based on epidemiology and supply-chain projections is a fool’s errand.
There will be pain. But there will also be a recovery. All the virus does is to postpone realized and unrealized gains in our portfolio. Thematically, our strategy remains intact. Our worldview is long-term and that hasn’t changed.
Long-term seems like a cop-out to some people. But it isn’t. We think in terms of growth vectors (investment themes) and fundamental analysis. But in this article, we explain the benefits of long-term investing in simple numbers and facts.
Keep the Faith. Wait.
The natural tendency of stocks is to go up. That’s the inertia. Sometimes, things happen to stop the inertia, but order resumes over the long-term. And lost returns are gained back IF you stay invested. So, what is long-term? We say approximately 2 years. Why?
Let’s take the S&P 500 since 1990. We took 1990 as a starting point because:
- It’s a reasonable amount of data.
- We don’t think a pre-computer era is going to be informative.
- The 1918 Spanish Flu may be tempting but it was a different world, different set of companies, different market.
1990 to Now gives us decent information. At the end of the day, this discussion is about Risk. At The Buylyst, we define Risk not as Volatility but as “Probability of Permanent Loss X Magnitude of Permanent Loss”. Yes, they’re subjective. But today, we’ll make it numerical.
Below are a set of charts that show you the power of waiting. The more you wait, the lower your:
- Probability of Loss
- Magnitude of Loss.
First, let’s talk about magnitude. If we look at different time-periods, what’s the upside/downside comparison? What can we expect to make by “sticking it out”? Well, if you wait 1 or 2 years, magnitude of the upside starts really overshadowing the magnitude of the downside. The more you wait, the higher those returns are likely to be.
Ranges are OK but they’re extreme. We just showed them to make a point about magnitude. Now let’s introduce Probability. Let’s get a bit more statistical – let’s look at the distribution of compounded cumulative returns for the following time-windows:
- 5 day
- 1 month
- 3 months
- 6 months
- 1 year
- 2 years
- 3 years
- 5 years
Here’s how it looks:
The higher the frequency (no. of cases) of positive returns (right side of the distribution), the better it is. In English, this chart says: The longer you stick it out, the higher your chances of realizing massive upside. Probability of Gains AND Magnitude of Gains shoot up.
If this looks crowded, we’ve got another easy-to-digest metric for you. For each of the periods above, we compared:
- The average positive return vs.
- The average negative return
Here’s a chart of the ratio of Average Positive Return vs. Average Negative Return:
Notice how much better this ratio gets from 1 year onwards. Pain can linger for a while, but inertia finally takes over. The message is clear: Wait. Returns sort themselves out.
But wait for how long?
Give it a year.
We’ve got to be prepared to wait a year to see our money back. This is why long-term investing is emotionally tough, but it’s the right thing to do. Today, we see a 15% crash transpiring within a few days. We may have to wait a year to see this come back. The data tells us that it’s a pretty good chance we’ll recover in a year. Remember:
- This data includes the dot-com crash and the Great Financial Crisis of 2008.
- The natural inertia of stocks is to go up.
There have been 4 cases of 15% crashes in a 5-day period before (since 1990). Here are the returns in the subsequent time periods – the recovery:
Here’s how the same calculation looks for a 15% crash happening within a 1 month. There were 13 such cases since 1990, and here’s how the S&P 500 fared in subsequent periods:
Just for fun, we ran the same numbers for a 20% crash happening in a span of 3 months. In subsequent periods…
You get the idea. Give it a year, and US stocks tend to recover losses even from the direst “corrections”. I know that it’s hard to wait while the Coronavirus is eating our returns. But the data tells us that we should wait. We’ll get through it. It may take a year, but we must keep calm and carry on.
Selling or shorting or cashing out is just market timing. And if you heard Warren Buffett on TV on Monday, he reminded us that no one can time the market reliably. No one can “call the bottom”.
Stick with a long-term investment strategy. It’s not an excuse. It’s the smart thing to do. If you need one, use ours. We’re here to help.
Many Happy Returns.