Equity Prices In Reverse Gear

Equity prices have been in reverse gear since mid-September. Some broad market indices have already dropped over 10% and investors are becoming increasingly nervous. Nevertheless, there is no reason to panic. 

When stock market pricesfall more than 10%, it’s called a correction. And if they rebound shortly after, it has earned this name. However, if prices keep plunging past the 20% line, it’s deemed a bear market. These percentages are arbitrary markers that the media love to exploit to make headlines. However, they aren’t truly significant. 

Anyone investing in stocks should remember the words of John Pierpont Morgan (1837-1913), founder of J.P. Morgan Bank. Somewhat exasperated, he replied to a young man when asked where the stock markets were headed: “I believe the market is going to fluctuate.”

The best week, just like that

One of the best-known equity indices is undoubtedly the S&P 500, tracking the largest 500 U.S. companies. It was good for a headline this fall after the decline from the annual high on August 1 to October 27 broke through the 10% barrier (calculated in US dollars). This caused unease among some market participants. Some probably rushed to sell so they could watch events unfold from the sidelines. 

But how did the markets react? They promptly delivered the best stock market week this year. The S&P 500 Index jumped 6%. Those who sold shortly before are no longer so relaxed. What now? How to get back in? 

Philip A. Fischer wrote one of the best-selling books on private investing: “Common Stocks and Uncommon Profits”. Back in 1958, he argued that an investor should never sell from fear of a bear market alone. After all, if a company is sustainably good, its share price will see new highs in the next bull market far above present levels. 

One in ten cases

It is theoretically possible to buy back sold shares more cheaply, but it hardly ever works out that way. Phil Fisher on whether there’s an ideal time for it: 

“Theoretically it should be after the coming decline. However, this presupposes that the investor will know when the decline will end. I have seen many investors dispose of a holding that was to show stupendous gain in the years ahead because of this fear of a coming bear market. Frequently the bear market never came and the stock went right on up. When a bear market has come, I have not seen one time in ten when the investor actually got back into the same shares before they had gone up above his selling price. Usually he either waited for them to go far lower than they actually dropped, or, when they were way down, fear of something else happening still prevented their reinstatement.”

The author clearly shows the low odds of success: First the investor thinks the price will fall even lower; then he sets an anchor at the lowest price and only sees what he has already missed. Then he waits for a second chance, which never comes. 

That is why we at Gutmann don’t simply invest in the stock market, but in companies that are successful in the long term.