Investing’s Timeless Challenge: Patience

Birthdays. Anniversaries. Graduations. Bar mitzvahs. Promotions. Eagle scout-hood. Most milestones are a cause for celebration. But this weekend investors face one that doesn't bring much joy: Saturday officially marks one calendar year since the S&P 500 price index last hit a new high, with the gauge down -4.3% since.^[i] That markets have gone a year without producing any gains is frustrating, especially when you consider a primary reason for the flattish returns is the correction in between, which added big volatility and scary headlines to the mix. That one-two punch-volatility with no real rewarding payoff-likely has many wondering what's in it for them: whether stocks' volatility risk is worth it. Some pundits aren't helping either, seeing the lack of upside as a sign the bull market is petering out. But here we'd counsel caution: Both these camps of investors could be setting themselves up to make a behavioral investing error. Past market trends-up, down or sideways-are never predictive of where markets are headed. As difficult as it may be, we humbly suggest now is a time to remain patient and disciplined, as fundamentals suggest the bull market likely has further to run.

First, to get a technicality out of the way: US market returns over the last year are actually a smidge better than mere price levels suggest. Including reinvested dividends (total return), the S&P 500 breeched last May's levels about a month ago. It's pulled back slightly since, to sit 2.8% below its new record as we type.^[ii] Which raises an interesting point: Since 1926, dividends account for a little less than a third of average annual total returns. But most financial media outlets puzzlingly focus solely on market price levels. It is hugely unlikely you can invest in stocks and not earn a dividend, so a price-only fixation is pretty unrealistic. ^[iii]

But either way, price or total, returns are still basically flattish-and global stocks are a bit behind US and have not set new highs, dividends or no. However, though it may not seem so, flat (point-to-point) returns-even for periods as long as a year-aren't all that unusual in bull markets. Typically, like the current one, a bull market correction plays a role.

As we wrote on these pages recently, this is the ninth flat point-to-point period of at least 300 calendar days in a bull market since 1926. (Six flat periods before the present made it to 365 days.) In four of the previous eight, stocks rose over 20% in the 12 months after the prior high was eclipsed, and they posted double-digit gains in the year following the other four. The notion that flatness signals a waning bull market is out of step with both that point and the fact bull markets historically surge in their final stages. Giving up on stocks after periods of flatness could mean missing out on those outsized gains. Opportunity cost is money lost.

As frustrating as the past year may have been, it doesn't say anything about where markets are headed looking forward. Copious research shows past market returns have no bearing on future returns. Last fall, after markets dropped over 10%, some suggested the decline was the tip of the iceberg, extrapolating the downside forward. But markets bounced back sharply. In February, another sharp downdraft brought widespread fears a bear market loomed. But stocks defied these calls, rallying back to near previous highs within a few months. This is the sixth correction in this bull market, and each time the story has been similar. Extrapolating market direction is a behavioral error. No matter how much or how little stocks rise or fall, they can always-and often do, change direction with no advance notice.

If you need equity-like returns (for some or all of your portfolio) to achieve your financial goals, you need to be invested most of the time. No other way to do it. Selling out of stocks and going to cash, bonds or something you believe provides safety when times get tough may feel good, but unless you are a superlative market timer (we aren't aware of any), you risk lowering your long-term return. Those lower returns can jeopardize your goals.

This isn't to say, though, you should remain invested all the time. If you have a sound reason to believe a bear market-a fundamentally driven decline of at least 20% over a meaningful period-is developing, it may make sense to reduce exposure to stocks. But the key is you need to have identified a powerful negative others aren't seeing to justify this kind of move. A correction driving flat point-to-point returns in the recent past doesn't qualify. It's backward-looking and subject to recency bias-a human trait where folks (consciously or unconsciously) expect what just happened to repeat.

There is little sign a bear is approaching now. The yield curve-a proxy for banks' willingness to lend-remains positive. The Conference Board's Leading Economic Indexes (LEI) are in long uptrends, suggesting growth ahead. April's US LEI, reported Thursday, rose 0.6% m/m, extending its uptrend and, since 1959, no US recession has started when LEI is rising. Politically, eyeballs are on elections and referendums, but the key for now is most major world governments remain bullishly gridlocked, reducing the chances they pass sweeping legislation radically affecting property rights. Sentiment is far from the euphoria typifying market tops. The three key drivers-politics, economics and sentiment-point to continued bull market.

In a bull market, returns often come in clumps or bursts-not smooth climbs to ever-higher levels. When those bursts come is almost impossible to know, so remaining invested most of the time-and remaining patient-makes the most sense. We know that can be challenging, and having faith in a more fruitful future is trying during frustrating times like this. But it's worth remembering this pearl of wisdom from Warren Buffett: "The stock market is a device for transferring money from the impatient to the patient." We know which side of that transfer we prefer.