Different Makes a Difference

The Odlum Brown Research Blog

Don't Be Fooled by the Markets

By Murray Leith CFA, Executive Vice President & Director, Investment Research
Wednesday, September 30, 2015

“Wall Street indexes predicted nine out of the last five recessions.”

- Paul Samuelson

It has been a tough year for equity investors, with volatility increasing and the major market averages performing poorly. Resource-related stocks have been hit particularly hard, which makes one wonder if the market is telegraphing a global recession. 

Markets are often very efficient at foretelling economic trends, but they can also give false signals. As the well-known economist Paul Samuelson famously quipped, “Wall Street indexes predicted nine out of the last five recessions.” In other words, the market gave the wrong signal four out of nine times.

We think we are at one of those junctures where the collective wisdom of the crowd is wrong. 

While there is legitimate concern regarding the economic slow-down unfolding in China, low interest rates and depressed commodity prices are stimulative factors that should provide an important offset. 

Recessions typically occur after the price of oil rises significantly, not after a big drop, as has occurred recently. Likewise, economic contractions normally happen after a considerable period of tight monetary policy, not at a time when most of the world’s central bankers have the monetary flood gates open. There is always a chance that “it is different this time,” but history suggests otherwise. Odds are that the global economy will continue to muddle forward, with fits and starts, as has been the case since the 2008/09 Financial Crisis.

Stocks are cheaper than they were a few months ago, and for that reason we are generally more constructive regarding prospective stock market returns. While some stocks may be appropriately discounting the consequences of a slow-growth world, others are behaving as if a recession is looming. In many cases, we think the proverbial investment baby is being thrown out with the bathwater. 

If the global economy proves to be more resilient than feared, stocks should find a footing. In the long run, we firmly believe that stocks will continue to be one of the best ways to preserve and grow wealth. Those who accept market volatility and remain committed to owning shares of good businesses invariably do better than those that try to anticipate economic cycles and time the market. 

François Rochon, a very successful portfolio manager, made a compelling case for sticking with stocks in a recent article in The Montreal Gazette. His wisdom is worth repeating:

Investors should embrace stocks: Historically, they have risen by about 7 per cent a year, reflecting the intrinsic growth in corporate earnings. Add to that an average dividend yield of 3 per cent and you get the 10 per cent long-term annual return of stocks. This kind of return over the long run can do wonders: every seven years you can double your capital. Let’s say you start to invest at 25, when you reach 67 you will have made 64 times your money (compare that to leaving your money in bonds or cash that yields close to nothing these days).

The only drawback to this incredible wealth accumulation potential is the need to live with the ups and downs of the stock market. Over a 42-year time frame, you would probably live through four recessions, 14 market corrections of around 10 per cent (one every three years) and something like six or seven bear markets (corrections of more than 20 per cent). You have to learn not to be affected by such events and must accept them as a normal part of the investing experience.

It’s hard to stay the course and do nothing when the media is warning that the sky could fall and investors are heading for the exits. Yet, the long-term history of the market clearly shows that patient investors reap the biggest rewards. As Howard Marks, Chairman of Oaktree Capital Management, said in a recent memo, “it’s not the things you buy and sell that make you money; it’s the things you hold.” 


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