“And it’s so easy to be blinded by the light” – Caamp
Jim Shellenberger, CFA, CFP® | Financial Advisor
It is always tricky to know where the middle ground is versus what is exaggerated to help drive clicks and views when it comes to the news. I would argue it is even worse in the finance world because, for most people, finance news can be boring. The news outlets know this – and they also know that people preferentially consume negative content due to the human ‘negativity bias’. So, what do they do? They often emphasize the bad news. After all, they’re running a business and it comes down to generating revenue, right?
However, what if we weren’t “blinded by ‘the news'” and instead used it in our favor to be a contrarian. I am not saying that there aren’t truthful news reports out there but let us not get sucked into the emotion of what is being reported. Warren Buffett put it well, “Be fearful when others are greedy, and greedy when others are fearful.” This means that when sentiment is negative, we should be more optimistic, and when sentiment is positive, we should probably be cautious.
There is plenty of scary news out there, and as usual, no one truly knows what is going to happen. We all have educated predictions, but as it has been since the beginning of time, the future is not known. Recently, with the Russell 2000 Index (which tracks U.S. small-cap stocks) down a little over 18% from November 2021 through April 2022, I decided to do a little research. I looked at monthly return data from 1979, where U.S. small cap stocks were down more than 15%. There were 15 time periods over these 43 years where the Russell 2000 was down at least 15%. Two things to note:
- I looked at historical times where the monthly return had, at a minimum, a 15% loss and then looked at what the return was for the next three months, twelve months, and three years. This means I was not showing data from the bottom of the market but rather trying to be consistent and look at the first point in time where the market had at least a 15% loss.
- I didn’t want to include data from the same 12-month period. For 2000 and 2008, I felt it was powerful to capture the first point the loss hit 15% and see what the future returns were and not overlap too much of the data. The table below shows the results.
|Date||Next 3 Months Return||Next 1 Year Return||Next 3 Years Annualized Return|
|% Positive Return||87%||87%||93%|
Here’s what stood out:
- The future is unknown: Just because the average one-year return was +28% after the market was down 15% does not mean that will happen today. The market could very well continue to go down. Look at February 2008. U.S. small stocks were down at least 15%, and then the next 12 months ended up down 37%.
- Don’t get caught up in the emotion of fear: It is important to understand that the annualized return since January 1979 for U.S. small stocks was +11%, but the average 1-year return after a 15% decline was +28%, and the average 3-year annualized return was +17%. It was beneficial for investors to not get caught up in the emotion of fear when the market was going down but rather to be contrarian.
- Have a discounted mindset: 93% of the time, the return was positive for the 3-year number, and the one time it was negative, it had an annualized return of -1% in 2000 when the market took a few years to get to the end of the drawdown. So, when the market goes down, have the mindset that things are now potentially discounted. Perhaps, think of it as a sale at a store and that you may have the opportunity of getting a better deal than you could have gotten a few months ago.
So, when I say be contrarian, I am saying maybe we should be asking ourselves, “How can I find more money to invest as the market goes down?”
If you are at the stage of life where you are not still contributing, that can be scarier because you don’t have money coming in to capitalize on market downturns. I completely understand that fear. To help soften the fear, I would point you to the fact that if we looked at these down periods of at least 15%, it took, on average, 24 months to get back to where we were. That means, if you had $100,000 and your account went down to $85,000, it took an average of 24 months to get back to $100,000. I also would point out that you are most likely not invested all in U.S. small stocks but rather a more conservative portfolio. It’s another reason why the news can be blinding. It is easy to talk about whatever is down the most, which tends to be stocks, but stocks are most likely only a portion of your portfolio and not the entire thing. The point of diversification and usage of investments like bonds is to seek to minimize these drawdowns.
I don’t care what anyone’s financial knowledge is; I believe the most significant thing that can hurt someone can be themselves. There are reasons why Warren Buffett can be so successful by being focused on the long term. We need to not get caught up in the emotion of the financial news and stop checking accounts every day. Let us not be blinded by the emotion of the news and turn off CNBC. Instead, try to be a contrarian. According to Warren, when the news turns extra negative and the people around you are most fearful, you might want to get a little greedy.
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|Russell 2000||Measures the performance of the small-cap segment of the U.S. equity universe|
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