CUT YOUR LOSSES, OR STICK AROUND FOR THE RIDE?
Mark Lister, 26 May 2022
I feel for those new to sharemarket investing.
With the S&P 500 in the US down almost 20 per cent from its January peak and the NZX 50 not far behind, those who entered the fray during 2021 won’t have had a great experience.
Some will be tempted to get out completely, cutting their losses in case markets fall further.
If you’re a trader with a six-month time horizon, maybe that’s the right approach.
There’s every chance things get worse before they get better, especially if inflation remains stubbornly high and the response from central banks (which is higher interest rates) leads to an economic downturn, or even recession.
However, if your foray into share investing is part of a longer-term strategy, based on building your wealth and generating a sustainable, growing, income stream for retirement, you’ve got a more difficult decision to make.
If you fall into the latter camp, you’ll presumably want to re-enter the market when all this blows over, which means you’ll not only need to judge whether now is the right time to bail, but also when you should get back in.
There have been six occasions since 2000 where the S&P 500 has fallen more than 15 per cent. The average fall across all six was a 32.5 per cent decline, and the average duration of the downturn (from top to bottom) was ten months.
Each of those times, when things turned, they turned quickly.
In the first month after the bottom, the average return was 17.3 per cent. After the first three months, it was 24.6 per cent and after the first 12 months it was 46.2 per cent.
Unless you’re extremely good, you won’t recognise a market bottom until it’s behind you and by the time you jump back in, you’ll have missed a fair whack of those gains.
Financial markets look forward. They take all the information at hand, form a collective judgement about the future, then factor that into today’s prices.
At the moment, prices reflect the many challenges on the horizon, even though we haven’t seen all of those show up in the economic data or earnings releases just yet.
It’ll be the same on the way back up, whenever that is. The bottom will come long before we see firm evidence of a clear path ahead.
Cast your mind back to March 2020 when COVID-19 first emerged. The NZX 50 index fell 33.9 per cent and it bottomed out on the 23rd of March.
The borders had only just been closed at that point, and two days later on the 25th we went into a level four lockdown.
In the real world, things were just starting to get ugly.
However, In the world of financial markets, investors had sniffed that out early and reacted in advance, and things had already turned the corner.
By the time the Prime Minister was outlining plans for our move to level two seven weeks later, the NZX 50 was already more than 25 per cent up from the bottom.
It was similar during the GFC. The S&P 500 bottomed in March 2009, even though the US economy was still in recession at that point.
The recession ended in June of that year, and by then the S&P 500 had rebounded more than 35 per cent from its lows.
It’s impossible to pinpoint how much worse this sell-off will get, or where the bottom is. Things will eventually turn around, as they always have, and nobody rings a bell to tell you when.
Whether you get off now or stick around for the ride is up to you, but first consider what you’re trying to achieve and if you’re good enough to also get back in at the right time.
You might be better off to strap in and stay put.