Nothing confuses people more than trying to understand what’s happening in “the market” these days. To make sense of it, you first have to understand two very simple distinctions. First off, “the stock market” is what the media refers to as one big ball of publicly traded stocks all lumped in together. Inside that ball, there are big companies, small companies, good companies, not-so-good companies, US companies, foreign companies, and so on. It’s no wonder you can’t make sense of it. The second distinction is that you can’t really own “the market” itself. It’s just a general proxy or term that refers to the stock market, and any references to it going up, down, or sideways are broad generalizations that tell you nothing.
Rather than trying to make sense of it from the top down, let’s look at it from the bottom up. If you invest in an index of the 500 largest companies in the US (like the S&P 500), what you really own is shares of some of the best managed companies in the world. Indeed, for every dollar you invest, you’re literally buying shares in each of those companies. That is what you own.
Now that we’ve cleared that up, what should you – as an owner of all these companies – know about them?
You should know that every day, the management teams of all these companies go to work with one long-term goal: To increase the profits of the company (and thereby the price of their stock) for their shareholders. Their decisions about spending, saving, buying other companies, hiring more employees, etc., are all driven by that goal. Because, in most cases, they are shareholders, too. So are their employees. And their Boards of Directors.
All businesses, no matter how well run, face the same challenges. Rising costs, slumps in demand, recessions, government regulation, and so on. The economy goes through cycles of growth and contraction, and all businesses must navigate them successfully to keep growing. So, how have they done over time? Let’s use their stock prices as an indicator. Going back to 1900, the share prices of the 500 largest companies in this country averaged a return to owners of approximately 10% per year. (It’s been about the same average return over the past 20 years and a little higher over the past 10.) To summarize, if you’ve just owned shares of these companies over the long run through all market conditions, you’ve done quite well.
The problem is – most people don’t have the constitution (let’s call it “emotional aptitude”) to hold them during the difficult periods when things aren’t going so well. Indeed, in the last fifty years, there have been three separate time periods when the value of your holdings was briefly cut in half before recovering and marching forward to new highs. Which brings us to our next point:
The daily prices of company stocks in “the market” are meant to reflect the company’s perceived overall value and its prospects for future growth – at that moment in time. In short time periods of relative calm, the markets are pretty good at this. But in times of uncertainty and stress, it can get messy in the short run. Let’s take 2020 as a recent example. When the pandemic struck, “the market” declined by roughly 34% in three weeks. While rationality was in short supply during that fearful time, most readers might certainly agree that a third of Company ABC’s total enterprise value did not just evaporate in three weeks. (It almost sounds silly to say it.) The lesson here is – stock prices can vary widely from a company’s actual worth in uncertain times. But when certainty returns, and things calm down, stock prices recover to reflect a company’s real value. We’ve said this many times, so we will say it again:
Every single time throughout history “the market” has declined, it has recovered and gone on to new highs. Every. Time.
And before anyone says, “Well, why don’t we just get out at the top and buy back in the bottom?”, we will remind you – there are no facts about the future. How long and how deep the crisis du jour will be is fundamentally unknowable by anyone. We just know that whatever today’s crisis is – it will end, and another one will take its place. That’s how this works.
So next time we encounter choppiness in the markets, remind yourself that short-term declines in value represent an opportunity to buy quality companies at reduced prices. Once certainty returns to markets, prices recover.
The S&P 500 index is an unmanaged portfolio and individuals cannot invest directly in the index.