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The current market situation probably has many investors worried about the long term outlook of their holdings. In my opinion, this worry is not founded and every long term investor should be optimistic over the long term, more so if they are investing in quality companies. Why should optimism reign the mindsets of long term investors? This is exactly what this article tries to address, the reasons why I chose to be a long term stock market optimist.
Let’s get started!
History shows that you can trust the stock market long-term
I know that past performance is not necessarily a good proxy for future returns but the truth is that although history does not repeat, it usually rhymes. Through history, the stock market has faced many drops (some more severe than others) but it always managed to recover and come back stronger. If you want the most recent example you can take a look at March 2020 and the subsequent market recovery and market run.
When the market is dropping and sentiment turns pessimistic, I always look at the following chart once in a while to zoom out and remind myself that I have to remain long term oriented if I want to make money in the market. You should save this graph, pin it, print it and dream with it!
Source: “Stocks for the long run” by Jeremy J Siegel every
From this graph you can learn two main lessons:
Stock market history shows that stocks go up over the long run and provide an adequate annualized return (CAGR).
Holding cash for long periods of time is one of the worst strategies any person can pursue, more so in recent times when money printing has skyrocketed.
Revenue growth leads to long-term shareholder value creation
Many investors are obsessed with focusing on what variables may be moving the market over the short run so they end up being caught in market noise. You probably have heard the words “Inflation”, “Interest Rates”, “CPI” over and over again during the past weeks and if you are focusing your energy on predicting how these variables are affecting your holdings, you are making a huge mistake in my opinion. Why? Because long term value creation over the long term is mainly influenced by revenue growth. Take a look at this graph:
For the last 30, 40 or even 50 years we have gone through many interest rate and inflation environments but the stock market has always trended upwards. Do you have any doubts? If you do, I want you to analyze closely the following three graphs. Now superimpose them in your head and try to find some long-term correlation between them. Can you find it? I can’t.
Here is what the Dow Jones has done in the past years:
This is how inflation has evolved:
And this is how interest rates have evolved:
Undoubtedly they affect in some way the stock market in the short run but I think that your time is much wisely spent studying fundamentals than predicting CPI numbers or the evolution of interest rates because, let’s face it, none of them is under our control as investors. The thing that is under our control as long term investors is deep understanding of company fundamentals.
Just try to answer this simple question:
“Do you think that the CEO of any company (not financial services) goes every day to work thinking about inflation or interest rates?”
The obvious answer is no. The CEO is probably focused on growing the company which you own part of and, if he is not worried about those variables, you shouldn’t be worried either.
If you want to stay invested for 20 - 30 years you’ll probably go through many macro environments which will have differing effects on your holdings. As time goes by these effects will dissipate and great companies will do what they usually do: grow and outperform.
The stock market favors the optimist investors
Last week my Fintwit friend Conor (@InvestmentTalkk) shared a report that argued that a “Buy and Hold” strategy would’ve clearly outperformed a “Buy The Dip” strategy. The report states the following:
"An investor who invested $100 in the S&P 500 in 1960 and held onto their investment would now have $43,132. An investor who employed a BTD strategy of buying in 1960, selling at new ATHs and waiting for a 10% correction before buying back have a portfolio worth just $534."
Source: UBS Monthly Letter, Mark Haefele
This research is basically telling you that it is more profitable to remain a long term optimist rather than falling in the mistake of timing the market and waiting for a dip that may take years to come. Our good friend Peter Lynch also had a similar feeling:
“Far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in corrections themselves.”
I didn’t need a report to back up my thesis that buy and hold is the best strategy for me but oh well, now I have one piece of research to back it up. You need patience and you need optimism to hold on to your investments but the market clearly rewards those investors who are not trying to time it.
You are buying companies, not stocks
I think that you would agree with me that stock price eventually follows fundamentals. It may take 3, 5 or 10 years, but it will follow eventually. Many investors know this but many of them end up panic selling their holdings even though the underlying companies are continuously improving their fundamentals.
To avoid panic selling I normally do the following: if I bought a stock at any given price because I thought it was a good buy at that price, I will automatically stop following the price and I will only follow fundamentals. If fundamentals deteriorate I will sell the stock, regardless of price. If stock price falls but fundamentals improve I’ll buy more if I don’t have a full position.
Remember that what you are really holding are companies, not stocks. If the business is growing, the stock will follow over the long term and you just have to be patient. Don’t let the stock market misguide you when it does not price your companies correctly over the short term. Let the market prove your right (or wrong!) over the long term.
No, the market is not short term efficient
Many people will try to convince you that “x” or “y” stock is overvalued based on the information there is available today. While this might be true, what they are omitting is that great management will create value from sources that are not even known today so many stocks that appear to be overvalued may in fact be ridiculously undervalued going forward. This is why you should study management in detail before allocating a single dollar to their companies.
I am not saying that you shouldn’t look at valuation at all, what I am trying to say is that great management needs your patience to create value and outperform, but they will eventually execute and you need to be there to enjoy your share of this value creation.
If Efficient Market Theory (EMT) holds over the long term then outperforming the market should be impossible. Spoiler: it isn’t.
Remember that history doesn’t repeat but it often rhymes
Many bears will try to tell you that this time everything is different and the market will face a severe crash and will not recover. Have people predicted severe and permanent crashes before? Yes. Have they been right? No.
Final thoughts
I think that I have made clear in this article that I am a long term stock market optimist and I have given you my reasons for it. After these weeks where growth stocks have collapsed you might think that everything is overvalued and that the stock market is facing a definite end (specially if you are a newer investor) but probably when you look back at this in 10 years this might just be a small bump in your journey.
Lastly, I would like to share something I tweeted a couple of days ago:
Optimism is the way to go when investing and when living.
Are you a long term stock market optimist? Let me know!
Stay well!
IQ