- Towards every bear market bottom (and bubble peak), investors question the long-held faith in stocks' ability to outperform other liquid asset classes going forward.
- Part of the blame is inevitably leveled at "quants," hedge funds, short sellers, and other short-term speculators. But the notion short sellers can manipulate stock prices at will is mistaken.
- Short-term volatility has never inhibited long-term value recognition or positive returns. It's subversive to think it will during bear markets.
Holding onto anything for the long term involves some risk. Cottage cheese, not so desirable. But cult wines and modern art? It's a good guess they'd rise in value—though there's still risk along the way. Same goes for stocks. Investors know stocks deliver superior returns relative to other liquid asset classes over time (including bear markets and the like), but that doesn't make near-term volatility any easier to swallow.
Towards every bear market bottom (and bubble peak), investors question the long-held faith in stocks' ability to generate value over time. When broad market volatility drives prices down (or up) beyond logical reasoning, there's fear stocks' price movements are no longer attached to the same fundamentals, calling into doubt investing in stocks for the long-term. However, believing "this time it's different" is a classic investing misperception. Inclusive of bear markets, stocks have generated an average total return of 926% over 20-year rolling periods since 1926 (and 2540% over 30-year rolling periods).*
Part of the blame is inevitably leveled at "quants," hedge funds, short sellers, and other short-term speculators. Last year's financial crisis turned into a veritable feeding frenzy for short sellers, who in turn clouded waters with masticated stocks. But how much do short-term traders' actions actually impact overall markets? There's no question short sellers can add to volatility—but most often they are augmenting market trends, not creating new ones. No hedge funds or traders have ever brought down a profitable, well-run company.
The reality is there have always been short-term traders, and their actions have always had a short-term impact on market performance. But the notion short sellers can manipulate stock prices at will is mistaken. If a trader pushes a stock's price too far beyond its intrinsic value, another trader will opportunistically push the price back closer. And while speculators are often blamed when markets decline, the liquidity they provide (through short-selling) is a key part of the price discovery process and effective functioning of markets.
There is no perfect way to determine a stock's exact worth on a fundamental basis at any given time—markets are never perfectly aligned with value in the near term. That uncertainty is partly the reason behind short-term volatility, but short-term volatility has never inhibited long-term value recognition or positive returns. It's subversive to think it will during bear markets. The more investors there are in the market—both short-term and long—the better chances stocks can move closer in line with their values.
There's a reason why iconic professional investor Benjamin Graham said the stock market behaves like a voting machine in the short run and a weighing machine in the long run. There's also a reason why "this time it's different" are the four most dangerous words in investing.
*Source: S&P 500 total return index, as of 12/31/2008