Fear and greed are the two emotions that govern investing. When the market is going up greed takes the reins and the market is valued at levels far exceeding its intrinsic value. Then some doom and gloom comes along and fear takes over driving down valuations. Through all of this boom and bust the important things to remember are:
- Crashes happen
- The market recovers
Why do crashes happen in the first place? Well, first expectations need to become decoupled from reality. Folks really need to start believing that the market can only go up and this time it is different. This unfounded optimism drives valuations above and beyond any basis in reality. A company is only worth as much as the assets it owns and the profits it can deliver. If a company is being valued at massive multiples above its intrinsic value on the speculative guess that it can continue unbound growth in perpetuity reality is going to come knocking at some point. If this optimism is being applied to every company in the market a bubble is in the works. Bonus points if the shares are being bought with borrowed money. There is nothing quite like leverage to inflate valuations. At this point the bubble is good and inflated. But something has to happen to temper the optimism and cast some doubt on the trust that prices can go up forever. Sometimes it is a big flashy thing like one country lobbing some missiles at another country’s oil tankers and the other country retaliating by shelling an oil platform leading to uncertainty giving fear a chance to run amok. Other times it is something as small as speculation on the outcome of a FOMC (Federal Open Market Committee) meeting. Either way the uncertainty leads to fear, and when the herd is fearful and diving for the exits the result is a crash.
Why is it that the market climbs relentlessly up? A company is worth the assets it owns and the profits it can produce. Everyday people are making things and figuring out better ways to do things. To top it off the total population continues to climb. More people working hard every day making things, and figuring out how to make things more efficiently is the basis of the rising market. Barring some major disaster like the zombie apocalypse or over heating our little blue ball to the point that the environment changes faster than we can adapt to it I don’t see any way for the trend to not continue.
The market can be a bumpy ride. Just look at that dip in the middle of the summer in the chart below:
When stepping back a bit the dip in the summer of 2016 is less of a dip and more of a blip:
Over a short time period the market bounces around. Over the long haul it is incredibly hard to lose money. The little mortgage dust up in 2008 shows up on the graph but, even that is smoothed out with time. Showing the dip for what it was; a fantastic buying opportunity. Every couple of decades there has been a recession. There have also been several big long bull markets making up ground lost during the previous pullback.
I believe in people in general. They are industrious, always discovering new things, making things, and finding more efficient ways to do things. That I why I believe the market will recover from whatever woes befall it. I also believe in peoples abilities to shoot themselves in the foot and do incredibly stupid things on occasion. Like listening to the news and deciding to sell since the market is falling even though the underlying value of the company hasn’t changed one bit. That is why I believe in the markets ability to crash and dip, repeatedly and hard. With these two pieces of information in mind my strategy when it comes to investing is to invest, and let it stay invested as long as possible. Then I tune out the market news media and go happily about my business while my investments turn out dividend and interest payments that get plowed right back into more shares.