This is an essential part of Warren Buffet’s investment strategy. The idea is that most investors, as emotional human beings, are wrong when it comes to the stock market. Interestingly, when the stock market goes down, the number of calls we receive increases. When the stock market is going up, the phones are quieter. In down markets, we spend a great deal of time reassuring clients about maintaining the asset allocation that suits them, and not making dramatic changes based on the mood of day or what they see, hear or read in the mainstream media. It is particularly difficult to maintain a cool head when markets are volatile, and in August we have had several of the most volatile days in the past 50 years (most of them down). But that is the time when maintaining your composure is even more crucial.
As of this writing, the market is down about 17% from its high in April. It is up about 68% from the low on 3/9/09. This is referred to as a “correction,” or a decline of more than 10% but less than 20% from a previous peak. Corrections are not unusual, particularly after a big advance, and have happened on average every 2-3 years since the end of Word War II.
While no two corrections are exactly the same, we can examine historical data to see what has happened in the past. There is an old saying, which many attribute to Mark Twain, “History doesn’t repeat itself, but it does rhyme.” The current correction began in late April and has lasted about 3.5 months, with a recent low on the S & P 500 of 1119 set on August 9. Looking at the average since 1945, corrections have taken about 4 months to go from peak to trough and an additional 4 months to regain their previous peak.
A “bear market”, or decline of more than 20% from a recent high, has historically happened less frequently and had a longer recovery time. We do not believe we are going to experience a bear market, but are fairly close to that level of about 1090 on the S & P 500.
Yesterday the yield on the 10-year US Treasury Note fell below 2% briefly, the lowest level since the Eisenhower administration in 1954. Several of the companies that we invest in have current dividend yields of 3% or more, and have raised their dividends each year for 30, 40 or even 55 years. If asked whether I thought their dividends next year will be higher or lower, I would say higher. Stock prices eventually follow growth in earnings and dividends (the key word being eventually). Most economists are forecasting slow but positive economic growth this year, and better growth next year. We believe stocks, particularly high-quality, dividend-paying companies, are currently very attractively valued relative to bonds and other assets such as gold. While high-quality companies have lagged somewhat in performance off of the 2009 market bottom, we are seeing many such companies with good and rising dividends and earnings. We believe that a diversified portfolio of such companies will position our clients well as economic growth continues to improve.
Bill Hansen, CFA
August 19, 2011