Tales of a Technician: The Upside if You Buy Stocks Now
May 23, 2022
Pull up a long-term chart of any major U.S. index and identify the best times to buy. Do you know what you’ll discover? The entry points with the most upside occurred immediately following a crash or major bear market.
But they required you to have the intestinal fortitude to buy at a time of peak uncertainty.
Like now.
There are a million reasons why you should NOT BUY now including inflation, the hawkish Fed, rising interest rates, supply chain distortions, the Russia-Ukraine war, and asset prices in freefall.
It’s easy to look at past crises and say you should have bought. You’re distant, objective, and unemotional. Moreover, you know how the story ended – with recovery and a march to new highs.
But what about now? When we’re in the thick of scary things and it seems like the dumbest thing in the world to buy stocks. It’s not so easy in the heat of the moment, now is it? You don’t get a fire sale without a fire, and I’d say there are multiple infernos trying to burn down Wall Street now.
Of course, you can wait for the flames to be put out. Fast forward six months to a year or two and this will all be a distant memory. But so will the sale! Buying with more certainty = buying at higher prices.
Fear vs. Historical Evidence
As Jeremy Siegel quipped in his delightful book Stocks for the Long Run
“Fear has a greater grasp on human action than does the impressive weight of historical evidence.”
History says those with a long time horizon should be buying bear markets double-fisted. Fear says they should flee to cash and wait out the storm. Which one wins out in your mind will determine your success as an investor.
In helping to reframe the upside, here’s a great trick I picked up while reading Just Keep Buying by Nick Maggiulli.
Here’s the situation. Suppose the stock market is down 33% like it was in March 2020 during the global pandemic. If you expect the stock market will eventually recover to a new high, then you can calculate the expected annual return based on how long you think it will take.
…if you think the market recovery will take:
- 1 year: then your expected annual return = 50%
- 2 years: then your expected annual return = 22%
- 3 years: then your expected annual return = 14%
- 4 years: then your expected annual return = 11%
- 5 years: then your expected annual return = 8%
The Russell 2000 was down close to 33% at its recent lows so it’s a good example to use for the current crisis. The first question is whether you think it will recover back to the old high of $244.46. History obviously demands we answer yes. If WWII and the sky-high inflation of the 1970s didn’t do the market in, then I assure you the current wrestle with inflation won’t either.
Okay, so the market will recover. Where opinions vary is on the time horizon. Optimists will say the Fed doesn’t tighten too far, inflation gets under control, corporate profits keep humming along and we’re back to a new high by next July. In which case, buying IWM offers the potential for 50% upside from here.
But what if it takes longer to pull us out of the current crisis? Even if you think it takes five years. Buying now still offers 8% annual returns which is close to the long-term historical average of stock market performance.
If you truly are a long-term investor, how can you not find these numbers compelling? By reframing the situation and thinking about the future upside from here instead of the short-term (and temporary) downside that may still be lurking, it’s much easier to pull the trigger and put money to work.
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