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I grew up an hour from one of the world’s most famous amusement parks.
I used to love riding roller coasters as a kid. I lived for the heart-pounding moment when you're hurtling downhill, the world is spinning, and you're not quite sure when the drop will end.
And for anyone who’s been investing in the stock market the last few years, this feeling is all too familiar…
…but this “volatility” is the price of admission for building wealth.
This Pullback Isn’t a Huge Surprise
I’ve received more than a dozen panicked messages like this in the last week:
Nobody can know for sure when stocks will bottom. But I understand why people are nervous as the S&P 500 has pulled back -8% from its summer highs.
And there are a few good reasons this is happening. As I outlined last week, there are three indicators I’m monitoring to see if the pullback is finished.
The first is US government bond yields. The worst bond bear market in US history took a breather this week as yields headed back below the dreaded 5% mark.
Second, I’m watching the S&P 500’s 200-day moving average. This technical level acts as the long-term trend for the market, and when stocks fall below the 200-day MA it’s usually a bearish sign.
Well, that happened this week (red line) which is a poor sign for the technical health of the S&P 500:
But the biggest factor pulling the market lower is underwhelming Big Tech earnings.
Earnings Drive the Market
I know I can sound like a broken record in this newsletter when it comes to earnings.
But I put such a strong emphasis on them because they can make or break the stock market. At its core, stocks are priced based on their future earnings expectations.
So when companies like Alphabet (GOOGL), Meta Platforms (META), and Amazon (AMZN) report earnings below what investors expect, it tends to spook investors.
And when you factor in that those are three of the companies propping up the stock market, you have a recipe for an earnings-induced pullback:
But while the last few months have been an amusement park-style roller coaster, this is all very normal.
And you shouldn’t let it shake your resolve as an investor.
Weak Hands to Strong Hands
Dealing with market volatility - or the rapid and unpredictable price swings - is something all successful investors learn to deal with.
And it can take time getting used to. For instance, your first instinct when your portfolio value is dropping is to “head for the hills” and sell everything.
But when you get those types of feelings, it’s often helpful to seek the sage advice of some of the best investors in history. For instance, Peter Lynch is one of the best performing mutual fund managers of all-time. He had this to say about dealing with market volatility.
“The key to making money in stocks is not to get scared out of them. Investing in stocks is an art, not a science, and people who've been trained to rigidly quantify everything have a big disadvantage. All the math you need in the stock market you get in the fourth grade.”
Lynch is saying that holding - and buying - stocks during tough periods it was makes a successful investor. If you only buy when everything is going “good” in the markets, you will only buy near the top of each market cycle.
This was a similar sentiment echoed by Warren Buffett.
"The stock market is a device for transferring money from the impatient to the patient."
Buffett is saying that anyone can buy a stock. But those who panic sell during tough times or panic buy during the good times are due to fail in the investing game.
Because in the short-tern, stocks may not move as investors expect. They will behave irrationally to “shake out” weak handed investors. This is why he says stocks are a device for transfering money from the impatient (i.e. weak hands) to the patient (i.e. strong hands).
Lastly, this quote from index fund legend John Bogle is also prescient in a time like this:
"Volatility is not a measure of risk; rather, it offers the opportunity for those who are patient and not unduly disturbed by short-term market fluctuations."
John is reminding investors that volatility is a feature - not a bug - in the investing game. Volatility is the price of admission to higher returns, and if you have patience the long-term payoff is immense.
Volatility is Your Friend
I will say my call that markets put in a short-term bottom back in early October is looking like it’s wrong.
While it’s never fun to be wrong (especially publicly), being incorrect is part of investing. The best investors on the planet are only correct 55% of the time, so I’ll put this call in the 45% pile for 2023 (as I’ve certianly got a lot right).
But while it looks like that call was a whiff, the points remains that the volatility we’re witnessing isn’t a reason to abandon the markets. Rather, it’s a time to manage the risk, cut under-performing positions before the losses get too big, and raise cash to buy assets on the cheap.
Because tough times in the markets don’t last forever. And when markets eventually find their footing, I plan to be positioned to ride stocks higher.
Stay safe out there,
Robert