But exactly why is it such a bad thing for investors to make money year after year? Why must we accept these facts as inalienable truths, instead of something to overcome? Sometimes, I have a hard time reconciling that myself. As an individual, I look for my wealth to grow (never contract!). Slow and steady growth of income is preferable to wild swings in annual income – unless the swings are only in one direction - up. This marks a good life. Why isn’t the same true of the economy as a whole? Why isn’t it true of the stock market, which should be tied to the economy?
Over the long-term, the patterns make sense, and the elements are in place for slow, stable growth. Labor force productivity increases, the labor force itself increases, the stock market marches higher. Over the intermediate term, though, the patterns are harder to predict. The market and the economy move as a function of the constant struggle for equilibrium in an ever-changing environment. Productivity leaps ahead and then stalls out. The economy grows and contracts. The market moves in unpredictable ways. The intermediate-term is marked by booms and busts. For a long-term investor, the short-term is noise. According to research by JP Morgan, the stock market has fallen over 5% about four times a year on average. Declines of two or three percent happen even more frequently, but recovery time is short as well. See the chart below as an illustration. It’s worth remembering that history supports a quick turnaround for normal market corrections. A short-term focused investor would get whipsawed trying to trade around them.
The Wall Street Journal ran a fascinating article on a Rust Belt city that manufactures RVs (link behind paywall) earlier this year. Far from the doom and gloom of Hillbilly Elegy, Elkhart, IN is booming. The local McDonalds had to close for lunch because it couldn’t fill its $8 an hour positions. Young people are skipping college to go straight to work in RV manufacturing, leaving a dearth of college enrollees and labor to fill lower-wage positions. Numbers from the Federal Government suggest that it’s not just Elkhart – the labor market in the US is tight. Tight labor market means rising wages, rising inflation, and inefficiency in company operations as jobs cannot be filled at a wage in proportion to the value it creates. On the investment side, stocks of bad companies perform just as well as good companies’ stock in the short term, leading to a false sense of security and causing investors to allocate capital to bad businesses. Bad loans are written, increasing the amount of debt outstanding that will likely not be repaid – i.e., baking in future losses. A bull market can’t last forever, because it sows the seeds of its own destruction. We’re seeing that already, though no one knows when the current cycle will end.
Balance is elusive. Our job as financial professionals is to help clients find that balance in the face of short-term noise and market fluctuations. Ultimately, investment success is not about a quarter gain or a quarter loss for our portfolios – it is about fulfilling the long-term goal of the portfolio. Perhaps that goal is to fund retirement, leave a lasting legacy, or in the case of an institution, fulfill a mission. There are a few nearly surefire ways to miss that goal, and one is focusing on the short-term noise instead of the long-term plan. We strongly believe that the best way to achieve long-term investment success is to continue to hold the course, investing with high-quality managers in a diversified investment portfolio.