Fresh off the second huge stock market rally from a frightening decline in the past year, I thought it would be timely to do a bit of reflecting.
For those with very short memories (or news avoiders), the stock market took an absolute nosedive in January through early February as oil prices bottomed out below $30 per barrel and Chinese growth concerns returned to the spotlight.
At one point, the Dow index had dropped over 2,000 points in a matter of weeks. I’d be lying if I said that there wasn’t an urge to cut and run at that point.
Of course, I felt the same urge back in August during the flash crash. And, what happened next? The stock market quickly returned to pre-crash levels in both cases within 2 months. Here’s a graphical depiction of both crashes and rebounds:
Identical lessons could be taken from each “crash and rebound” – namely, market timing doesn’t work. When you have the greatest urge to sell, is usually when you should be buying. Emotions mess with your rational thought process in the short-term. However, in the long run, panic tends to subside and market normalcy returns.
This reminds me of a great quote I recently came across:
In the short run, the market is a voting machine, but in the long run, it is a weighing machine.
There is a debate about the origination of this quote. Warren Buffet claims that his mentor Benjamin Graham once wrote this. However, the quote can’t be found in Graham’s two investing masterpieces Security Analysis or The Intelligent Investor.
Buffett claims Graham used to say this in his classroom (of which Buffett was a student). A similar quote can be found (from Buffett in reference to what Graham said) in the 1993 Berkshire Hathaway shareholder letter,
In the short-run, the market is a voting machine – reflecting a voter-registration test that requires only money, not intelligence or emotional stability – but in the long-run, the market is a weighing machine.
Regardless of the exact origination, the quote is brilliant and it is just as relevant today as it was back then – market prices represent (an often irrational) short-term popularity contest similar to voting for a political election, but in the long run they tend to gain in value due to return on capital, economic growth, and inflation (and for individual investors, dividends paid) – similar to a weighing machine.
It’s a quote that can be referred back to in turbulent times to help ease your mind as everyone else is panicking (passive index investing can help with that too).
And that tends to happen quite often these days.