ON SEPT. 11, 2001, I spent an hour and a half standing on a crowded subway train two blocks from the World Trade Center. During that time, both towers collapsed. No smoke came shooting down the subway tunnel. The earth didn’t noticeably shake. There were no deafening noises. Instead, we were just another subway car packed with disgruntled passengers, muttering about the perils of public transport.
It was only when the train backed up to Penn Station in midtown Manhattan that we learned what had happened that day. “They’ve hit the World Trade Center,” a policeman was shouting. “They’ve hit the Pentagon. And there are eight planes still unaccounted for. Everybody needs to evacuate the station. Now.”
In the days that followed, people took to saying, “The world will never be the same again.” Some folks bought gas masks. Many loaded up on basic provisions. Families settled on a safe place to meet, should another terrorist attack occur.
Sept. 11th was a terrible and terrifying tragedy that played out on television for all the world to see—and we should never forget the loss of life that day. By contrast, the resulting stock market plunge seems of little import. Still, there was indeed a large market reaction, one that offers three lessons for today’s investor:
1. Extraordinary market declines are anything but. Every decade or so, we get a big stock market swoon. All feel catastrophic at the time, and yet—in retrospect—they seem almost routine. Think back over the past half-century and what’s happened to the S&P 500.
We had 1973-74’s grueling 48% drop triggered by the OPEC oil embargo and escalating inflation, 1980-82’s 27% bear market wrought by a double-dip recession, 1987’s stunning 34% crash, 1990’s 20% decline following the Iraqi invasion of Kuwait, 2000-02’s 49% meltdown caused by the dot-com bust and 9/11 terrorist attacks, 2007-09’s global financial crisis with its 57% bloodbath, and 2020’s 34% coronavirus crash.
Each of these market collapses had a different cause and played out in a different way. Yet the smart way to behave was the same every time: Investors needed to grit their teeth, rebalance back to their portfolio’s target stock percentage and, if at all possible, shovel any extra cash into broadly diversified stock funds.
2. The talking heads are clueless. While many warned that stocks were overpriced in 2000, nobody predicted the 9/11 terrorist attacks. A few foresaw the dangers in the mortgage-bond market in the mid-2000s, but the magnitude of the financial fallout eluded almost everybody. Nobody predicted 2020’s pandemic.
In each case, the stock market’s collapse was driven by news—which, by definition, isn’t known ahead of time. The next big market decline will also be driven by news. I won’t forecast it and nor will you, which is why we should stop trying.
I have enough for retirement not because I’ve ever managed to predict a stock market decline. Rather, I have enough, in part, because I stood my ground when stocks collapsed and, indeed, I merrily bought more. We win the game not by anticipating market declines, but by knowing how to react when they happen.
3. Stock prices go to extremes. As John Lim explained in a recent blog post, share prices should reflect their intrinsic value, which is the present value of future dividends. What if a global pandemic causes all stocks to stop paying all dividends for the next two years? As John explains, stocks should—in theory—fall just 6.1% because that’s the drop in intrinsic value.
But, of course, share prices fell far more than that in 2020, and also in the other market declines mentioned above. Therein lies the opportunity for level-headed investors. I believe markets are reasonably efficient, meaning it’s awfully hard to identify stocks that’ll outperform the market averages. That’s why I’m entirely invested in index funds.
But while mispriced individual stocks are hard to find, every so often investors collectively panic and drive down the overall market more than the fundamentals justify. I can’t tell you when that’ll next happen. But when it does, I’ll be buying—and you should, too. This may sound like the cardinal sin of market-timing, but it isn’t. I’m not encouraging you to forecast the next big decline or to sit on a big pile of cash in anticipation of a market crash. But there will indeed be many more declines, and riches await those who keep their heads and seize the opportunity.