Don’t let the stock market distract you

By PATRICK CAIRNS

Anyone who has been paying attention to stock markets over the past few months would know that these are not ordinary times.

A couple of weeks ago, indices were hitting record highs, even though the world is still in the midst of a pandemic. In the second half of February, however, global markets went through a bit of a wobble.

Some previously high-flying stocks have sold off quite sharply. Tesla, for instance, lost 28% in just over four weeks.

There has also been a lot of unusual activity, such as what happened with GameStop, where a social media army pushed up the price of an unloved gaming retailer. This was an extreme case, but it was the kind of involvement from individual investors that is almost always only seen when markets have reached extreme levels.

Back to fundamentals

Ben Johnson, a director at Morningstar, noted in a recent research note that it seems that the market has “decoupled” from the fundamentals that usually matter.

Put another way, stocks have been going up because more people have been buying them. And more people have been buying them because stocks have been going up.

This is a short-term effect. As Johnson wrote:

“One theory as to why trees don’t grow to the sky suggests that gravity is the limiting factor. The taller trees grow, the harder they have to work to overcome gravity to pull water through their roots and distribute it to their extremities.

“Gravity has a similar effect in stock markets, though it goes by another name: fundamentals. Economic growth, earnings growth, inflation – these are the fundamental forces that shape markets. Markets will often defy fundamentals during shorter time frames, but over the long term there is no escaping them.”

Making a call

So, what does this mean? If fundamentals are going to matter again at some point, is another big crash inevitable? Have we already seen the start of one? Should you take your money out and wait for things to quieten down?

That might sound attractive, but the problem with doing it is twofold:

Firstly, timing the market requires two decisions. For the decision to get out now to ultimately be a good one, you also have to make a second decision: you need to know when to get back in again.

That is far more difficult to do. When markets fall, there is no way of knowing when they have hit their bottom.

In last year’s Covid crash, for example, it took just a few weeks for the market to fall from its top to its bottom. In the Global Financial Crisis, however, it took nearly two years.

It’s impossible to know what kind of market crash you are facing until after it has passed. Each one plays out differently, and so timing your re-entry is just about impossible.

Long-term investing

The second problem with trying to protect yourself by taking your money out of the market is that this is only ever a short-term solution. Over the long term, stocks remain the best way to grow your wealth.

Even despite the many crashes that have occurred over the past decades, the stock market has out-performed every other asset class for more than a century. And the only way to ensure that you see all of those gains is to remain invested.

There will be times when stocks fall. But they have never failed to recover. History has shown that, without fail, stock markets always go up over time.

Assess your portfolio

Generally, the best advice to investors when the market seems to be behaving irrationally, whether it is going up or down, is to do nothing. If you can sit out the swings in the short-term, you will benefit in the long term.

However, as Morningstar’s Johnson notes, sometimes you can also take these opportunities to think a little more about your portfolio:

“I don’t think investors should try to time the market,’ he wrote. “I do suggest that now is a good time to take a close look at your portfolio and ask some simple questions.

“Are you comfortable with your asset allocation? After markets bounced back, stocks might represent a bigger piece of your portfolio. This might be an opportune time to rebalance.”

But don’t get carried away.

“Once you’ve reacquainted yourself with your portfolio and gotten comfortable with your asset allocations, your best bet is probably to walk away from it for a while,” wrote Johnson. “Late Vanguard founder Jack Bogle said: ‘The stock market is a giant distraction from the business of investing.’ These words have never rung truer.”