The Risk in Reacting to December’s Reversal

Oh Santa Claus, where art thou? Seasonal adages tell us this is the season when the Santa rally lifts stocks to a cheerful year-end, but November’s rally has fizzled this month, with another big down day adding to the pain Thursday. This back-and-forth grind is frustrating, especially in the context of this year’s bear market. Just when it seems like stocks have turned a corner, negativity returns. It can make exiting stocks—even after this year’s declines—look attractive. But remember: There is a huge risk in reacting to reversals and volatility—it complicates and limits your ability to capture a recovery and, hence, stocks’ long-term returns.

Fisher Investments’ Founder and Executive Chairman, Ken Fisher, has long called the stock market, “The Great Humiliator”—think of it as a trickster-type character that loves fooling as many people as possible out of as much money as possible. Among its most tried and true tactics? Refusing to move in straight lines. Bull markets are long—but jagged—marches higher, usually with a few steep, sharp drops of -10% to -20% called corrections. Bear markets, by contrast, trace their declines below -20% in fits and starts. Brief rallies often interrupt the decline to give investors false hope that the pain is over. In a way, that makes the ensuing legs down feel even worse than they otherwise might—it isn’t just the pain of the declines, but the disappointment and shattered hope they bring.

Perhaps most maddening? Bear markets’ ends are clear only in hindsight. We know from stock market history that bear markets typically end in a V-shape, with a sharp initial recovery. But bear market rallies can also seem to take that V formation before rolling over again to new lows. That probably lends some extra trepidation to December’s decline, which has partly erased what had been a very nice rally from stocks’ year-to-date low on October 12 through November’s end. Is it a march to a new bear market low in the days or weeks ahead? Or a headfake to shake out the weak early in a new bull market? There is no way to know. Short-term moves, whether they come during bull or bear markets, are always impossible to predict.

But here are some things we do know. Stocks’ annualized 10.3% return since good data begin in 1926 includes all bear markets along the way.^[i] Even really really really bad ones like those in the 1930s, 2000 – 2002 and 2008 – 2009. Hard as it may be to remember and believe when stocks are down, bull markets have always followed bear markets. They have also regularly eclipsed the bear markets, rising more and for longer—the reward for the volatility.

So if you have been invested all year and seen your portfolio fall with the market, what do you do? Selling out now on the fear that more downtimes are in store might feel better. But it comes at a cost—and not just the cost of inflation eroding cash’s value. The cost is this: What if you are wrong and a bull market gets cooking much faster than you anticipate? How much return will you miss before getting back in? How long will that delay your portfolio’s recovery? How much of a setback will it be for your long-term return compared to if you had remained patient and disciplined? How will you know that recovery isn’t another headfake? Is the temporary emotional comfort worth those tradeoffs?

To achieve market-like returns over time, you generally have to be in the market—especially when stocks are rising. Given the impossibility of predicting and timing short-term moves, if you try to dance around near-term downswings, there is a high likelihood you will miss at least some of the upswings that follow them. Every bit of bull market you miss is growth that could have compounded over time, bringing you that much closer to your long-term goals.

Volatility will always be with us, but it cuts both ways. There are good times and bad times, and they often come in clusters—especially during bear markets and new bull markets. Is it possible that mid-October through November was just another bear market rally and we are now on the way to new lows? Yes. But is it probable? We have a hard time believing it is. Bull markets usually begin when sentiment is depressed, which sure seems to be the case now. Look at why pundits claimed stocks fell Thursday: They said good economic news was really bad news because it meant the Fed was likelier to keep hiking rates. That is emblematic of a sentiment phenomenon we call the Pessimism of Disbelief—all good news gets ignored or couched as bad. We have seen this for the past several weeks, and in our experience, it is foundational to new bull markets. If the overriding mood were hope, while this is counterintuitive, it would probably be a bad sign, not a good one.

Most importantly: Remember stocks look to the next 3 – 30 months. This rough patch of high inflation, war and wobbling economic indicators is widely known—not a surprise to stocks. But within that 3 – 30 month window, there is a strong probability of better days as the global economy works through today’s headwinds and builds a solid foundation. At some point, stocks will shift from stewing over bad news to pricing in that better future. That is how nearly every new bull market begins. And if you are investing for long-term growth, we think the most beneficial approach now is to ensure you are invested to capture that new bull market when it arrives, if it hasn’t already.