On Friday, the Dow fell 123 points. On Saturday, our youngest son, Edward, returned from Africa. He had escaped capture by a rebel army in the Democratic Republic of the Congo…walked 50 miles through the jungle…and eventually made his way to the US embassy in Kinshasa, where he was given a new passport.
As to the Congo, Edward reported to his grandmother: ‘Rich country (in natural resources). Hard place to do business. The local people are nice. Until they decide to kill you.’
Grandmother: ‘Why would you want to do business there?’
Edward: ‘Because it’s there. It’s a challenge. It’s an adventure.’
Grandmother: ‘You don’t get extra points in life by doing things that are not worth doing.’
That wise counsel in mind, we return to the stock market. As we explained last week, we can only know what is false, not what is true. Even as to what is false, we are sometimes surprised.
But since our ground is firmer on the ‘what we don’t know’ side of the hill, investing is best approached from a defensive position. Don’t worry about finding the best stocks or the best investments; just be sure you don’t have the worst ones. And don’t worry about missing the market’s best days…just watch out for the worst ones.
This view was recently confirmed for us by a study (thanks to Richard Russell at Dow Theory Letters for bringing this to our attention). If you missed the 10 best days of market action during the last 25 years, your rate of return would have been cut nearly in half. Instead of getting over 6% per year, your return would have been only 3.67%. On the other hand, if you missed the 10 worst days over the last 25 years, your rate of return would have risen to nearly 11%.
The lesson from this is familiar: If you can avoid the market’s worst days, you’re way ahead of the game.
This is true of a lot of things. Think how much happier your marriage would be if you could blot out the 10 worst days of it. Or what a nice life General Custer might have had if he’d managed to avoid that awful day at Little Bighorn!
But when do the market’s worst days arrive? We haven’t studied the matter, but you don’t need much study to know that they follow big run-ups in prices. 1929. 1987. 2000. 2008. Typically, you get big drops after a long period of gains.
A 20-year Bear Market in stocks?
Or in grandmother’s terms: Trying to capture the last gains of a bull market is probably not worth doing. Even if one of those gains turns out to be one of the market’s 10 best days (unlikely), it is still not worth the risk that you might stumble into one of its 10 worst days.
We bring this up today because we don’t want you to say we didn’t warn you.
One day — perhaps soon, perhaps not — the US stock market will have one of its worst days. It will fall maybe 1,000 points. Maybe 3,000 points. And unlike previous recent episodes, this time stock prices may stay down for 10 or 20 years.
Bear markets — and market crashes — are not hypothetical. They are real. They are part of the market cycle. They are a part of life.
What’s that you say?
Janet Yellen and intelligent financial management techniques have banished bear markets? Because the Fed will always come to their aid with more cash and credit, investors will never again sell stocks in panic; those days are over?
Is that true?
Never was before. But who knows? Time will tell.
Custer claimed there were ‘not enough Indians in the world to defeat the 7th Cavalry’ before he and nearly half of the 7th Cavalry were wiped out at Little Bighorn.
For The Daily Reckoning Australia