Two the Point — Laying the Foundation for Future Returns

This week we read an article written by Michael Batnick called “Back to Basics”.1 The message was simple, but incredibly important. Here, we review the key takeaways:

“All past declines look like an opportunity; all future declines look like a risk.”

It is easy to view past market declines as “buying opportunities” while current/future declines simply feel like risks to be avoided. Even today, amid a market that feels particularly scary, the decline thus far is rather ordinary – the 11th decline of 20% or more since 1950.

“If you can accept that the stock market decline might get worse before it gets better, and if you can accept that declines lay the foundation for future returns, you will be much better off than the person who thinks otherwise.”

Although the idea that major declines in the stock market have led to above-average future returns is intuitive, the emotions associated with living through the decline in real-time can cloud this silver lining.

“The American economy is not nearly as volatile as the stock market would make you believe.”

It is easy to forget that when investing in the stock market you are investing in real businesses…not just flashing red or green numbers on a screen. These businesses are run by people motivated to provide for their families, create new products, and earn money for themselves and their shareholders. The history of American business is one of great success – dividends have grown by 6% per year since 1988. Earnings have grown by over 7% over that same period.

The bottom line is that, based on historic trends, you are far more likely to regret putting cash into the market after a 30% move higher than a 30% move lower. You may not like the outcome 12 months from now, but in 3+ years, you almost certainly will. To that point, returns are much higher than normal after 25% or more selloffs.

The chart below demonstrates the history:
Source: Strategas Research Partners
[1] Michael Batnick, “Back to Basics”. The Irrelevant Investor. September 24th 2022.