Tales of a Technician: Record Highs and Nonlinear Stock Market Returns
October 25, 2021
The S&P 500 closed at a record high today. That means yet another correction has come and gone without derailing the bull. From peak to trough, SPY fell 6% over just over 30 calendar days. For what it’s worth, the recovery took less than 20 days.
Who says stocks fall faster than they rise!?
I kid. I kid. Usually they do. But not always! This isn’t the first time we’ve seen stocks rise faster than the previous decline. Powerful “V-shaped” reversals are a recurring characteristic of this bull market. Chalk it up to monetary and fiscal stimulus or whatever else you want. No matter how you square it, investors suffer serious FOMO when the trend finally turns higher.
One of the easiest trades on the board this year has been buying and holding broad market ETFs like SPY, IWM, QQQ, and the like. Heck. If you bought SPY at the beginning of the year and simply closed your eyes, you’re up 22%! Rather than whining about this being an outlier, or pointing out the obvious fact that market returns will at some point subside back to their historical averages (that is, 10% a year), how about you instead focus on how to get a piece of the ever-expanding pie?
And more, importantly, map out a way to allow yourself to handle the market volatility so you don’t get shaken out during every little storm that comes along. After all, those who sold last month in a fit of fear, completely missed out on the recovery.
Of course, gains haven’t come as easy this year to small caps. The Russell 2000 ETF (IWM) hit $234.53 in early-March. It now sits at $229.57 in late-October. For seven months we’ve traveled a circuitous route to nowhere. Obviously for long-term investors, months of sideways is hardly anything to complain about. Moreover, this spurt was preceded by one of the best rallies in history. After gorging on gains, the Russell deserved to take a nap for digestion.
As one who has owned IWM for years, I haven’t been all that put out about the lack of momentum. It reminds of two inescapable market truths:
- Asset returns are non-linear.
- You never know when stock returns will come. You just now that they will come.
Lumpy returns
All the term “nonlinear” means is that market returns vary widely from year to year. When people hear about the average annual 10% gains that U.S. stocks have generated over the past century, they mistakenly expect those returns will consistently arrive each year moving forward. This couldn’t be further from the truth.
Suppose stocks rise 50% one year, while falling 30% the next. do you known what the average return was? 10%.
But will that feel like your experience? Not at all.
The irony of the 10% average return that people throw around is you rarely, if ever see it. It’s far more common that stocks climb 20+% or even decline.
Knowing this helps me set my expectations and realize that long periods of below-average returns are inevitably followed by periods of above-average returns and vice versa.
The Schedule of Returns
The second truth is correlated to the first. Stock investors get rewarded handsomely over time. But the gains don’t arrive on a set schedule. Sometimes an entire year’s returns comes over the last week of the year. And since it’s not possible to be out during the first 51 weeks of the year when prices are monkeying around, but in during the last week, you must own equities the entire time. The months of volatility and boredom are is the price required for the stock market’s returns.
The fear of “buying the top” has left many would-be stock owners in the dust. I suffer from the same fear, but have overcome it by embracing the following:
- First, if it’s a long-term investment I’m usually buying a broad-based ETF, with a track record of recovering from every downturn.
- Second, I’m willing to own it long-term to ensure that I’ll be there when the recovery arrives.
- Third, I can accelerate the speed at which I recover by purchasing more after a large enough drop to lower my average cost.
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