May 17, 2022
A couple of years ago, after a long bull run, investors were in fear for their portfolios as COVID-19 took hold, so much so that I wrote a column on it that pointed out that such times in the past meant it was a good time to buy. In hindsight, that was some very good timing since it was a couple of weeks before the market bottom on March 23.
The bulk of that column focused on what happens after markets fall 15 per cent within a month. The short answer is that they usually recover pretty quickly.
Today, we have a situation that has some similarities and, as always, many differences. The S&P 500 is down more than 15 per cent year to date, but it wasn’t all in one month like we saw in late February and March 2020.
In 2020, the cause was clearly the onset of the pandemic. Today, you can pick your reason, whether it be war, inflation, interest rate hikes or the ongoing global pandemic. What is particularly interesting about investing is that history has shown the details of why matter less than the fear and greed that drives the shorter-term stock market.
Thinking about this fear and greed, one should always remember that stock markets go up over time. History has shown this happens by between 10 and 11 per cent over the long term for the S&P 500, and closer to nine to 10 per cent for the S&P/TSX composite. It also shows that markets will go up in roughly seven out of 10 years
As a result, unlike going to the casino, which will very likely eventually lead to you losing your money, investing in the stock market will very likely lead to growth eventually.
If we accept that stock markets generally go up, and that they have definitely been going down meaningfully so far this year, what suggests we are nearing a turnaround? The answer can be found in our current level of fear.
On May 10, the National Bank of Canada’s CIO Office released a report on its market sentiment indicator. Over the past 15 years, the indicator had only reached an “extreme level of pessimism” three per cent of the time. It has reached that point again.
What happened after hitting this level in the past? The S&P 500’s returns the following month were positive 80 per cent of the time, with an average gain of 4.2 per cent. Over three months, it was positive 85 per cent of the time, and had an average gain of 8.5 per cent.
Admittedly, the report is only looking at a 15-year window, but the general trend on extreme pessimism and market performance has a very long track record.
This still doesn’t provide any certainty, because there is never market certainty in the short term, but it does indicate that the level of pessimism now being seen suggests the odds are increasingly skewed towards a market rebound.
As Warren Buffett wrote in 2008, “When investing, pessimism is your friend, euphoria the enemy.”
The other reason for some optimism is the opportunity to invest in higher yields today than you could at the beginning of the year.
The world can definitely seem like a scary place right now, especially for investments, but embracing the fear with the cushion of higher yields should allow you to feel better about investing today.