Market Mysteries: Part Two
Updated: Mar 22
In our previous article, we discussed the uncertainties behind price movements in the financial markets, particularly focusing on the importance of investor sentiment. We further noted that no one—including professional financial advisors—is able to predict, with better than random accuracy, which direction prices will take in the short term in response to investor sentiment.
But the fact is that some investors achieve better results than others, and in this installment of our series of articles, we’ll take a look at how and why that might be the case. You may have heard the quaint rural expression: “Even a blind hog finds an acorn every once in awhile.” The point of this colorful phrase is that randomness and the law of averages play a part in the success of some investors, especially in the short term. But the flipside of this truth is that other investors who are less focused on immediate results and more interested in long-term objectives have, over time, built up an impressive record of success in the financial markets.
Certainly, there are asset managers who do research on individual companies and draw astute conclusions from data sets and calculations that would numb the minds of the average investor. But it’s helpful to remember that they are all using exactly the same data. After all, the Securities and Exchange Commission expressly forbids companies from giving out preferential information; it’s called “insider trading.” Thus, many are doing the same kind of analysis. These people set the market prices, long-term, and there is seldom a wide difference of opinion among the experts about the fair price to pay for any individual stock.
So, that leaves luck as an explanatory factor—if you could call it that. Imagine a contest where 10,000 professional investors are engaged in a coin flipping contest to see who can flip the most heads in a row. In the first round, simply by the law of averages, 5,000 (more or less) contestants will flip tails and be eliminated. The next round, 2,500 (or so) others are disqualified. Next flip: 1,250 contestants are left, then 625, then 312, then 156, and finally, at the end of the 7th flip of the coin, only 78 contestants are still standing.
At this point the financial press starts to take note. Who are these people who were capable of flipping seven heads in a row? What’s their secret?
The next round, 39 contestants are still in the game, and then 20, and then 10, 5, 2 and ultimately, purely by the law of averages, one person will have managed to flip 13 heads in a row. If this person were a mutual fund manager, he or she would be inundated with interviews from the consumer press, and millions of investors would be flocking to his or her fund, abandoning all those “losers” who dropped out of the contest long ago.
The point of all this is that there are no experts in what the market is going to do in the next day, week, month or year, and we can all stop feeling embarrassed that we don’t understand market dynamics well enough to take advantage of superior knowledge. What we do know, however, is that every day, all over the world, millions of individuals put their best efforts into adding value to their respective companies, incrementally, a day at a time, making the stocks in our portfolios a bit more valuable than they were the day before. This seems like a very slow process—because it is. But that is also why investing in stocks, patiently and without trying to figure out what the markets will do in the short term, has been remarkably rewarding. Right around this date in 1987, the Dow Jones Industrial average—basically, a small handful of prominent stocks—was valued at $851. An investor who held onto those stocks until 1995 would have seen that value grow to $4,000. As of this writing, the value is at just over $34,000.
The average return on stocks since 1957 has been just over 10% a year, and if you go back to 1926, you get roughly the same number. Over the last 50 years, the markets have been up on 53.7% of all trading days. As the following chart illustrates, since the end of the Great Depression, from 1941 onward, there have been only two rolling 10-year investment time frames when the S&P 500 index showed a (very slight) negative return, and hundreds where the returns were positive.
We may not be able to predict what will happen tomorrow, but there’s a very solid chance that the next ten years will reward the patient investor. That is literally all we know about the markets.
At Bernhardt Wealth Management, we help investors build diversified portfolios that reflect their unique characteristics and most important financial goals. Our objective is to help them position their holdings for the type of long-term success discussed in this article. To learn more, click here to read our recent article, “Global Events and Your Investments.”