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THE STOCK MARKET HAS been one of my life’s enduring interests. No, it’s not because I try to pick market-beating investments. I gave up on that nonsense more than three decades ago.
Rather, I’m fascinated by the way we humans engage with this maddening market that promises both riches and peril, and which seems both ruthlessly efficient and utterly nuts. What have I learned from a lifetime of following the stock market? The sad truth is, I find there’s precious little that I can say with any confidence.
Indeed, I remain convinced that the best strategy is to sit patiently with a globally diversified portfolio of index funds—an approach that requires no crystal ball and very little trading. That said, on top of this know-nothing approach, I’ve layered four key ideas about the stock market.
1. Failing to forecast. When I started investing in 1987, grumpy old men would regularly warn that the market was overvalued and that stock investors would soon receive the punishment they so richly deserved. These market “wisemen” would point out that shares were richly valued based on yardsticks like price-to-book value, dividend yield and price-to-earnings multiples.
And yet, as the years rolled by, stocks kept getting more and more expensive, and those who listened to the grumpy old men were the ones who got punished. It eventually dawned on me that investors couldn’t divine the market’s future by studying valuation measures, and today I pay them scant attention.
2. Holding steady. Every day, the market tells us what our stocks and funds can be sold for. But for the sake of our own sanity, we need a sense of our holdings’ value that’s separate from the market’s latest declaration.
No, we won’t be able to figure out what our investments are truly worth. Nobody can. But what we can do is constantly remind ourselves that the fundamental value of our stocks and funds fluctuates far less than their market price—a point made by finance professor Robert Shiller more than four decades ago.
To be sure, if we needed to sell, we’d have to accept the current price. But absent that, we should focus on what we own—companies with valuable assets that generate healthy profits and often pay reliable dividends—and we should hold that notion close, especially when pundits, panicked investors and plunging prices try to bully us into believing otherwise.
3. Freaking out. When valuing a stock, analysts often start by estimating the profits that a company will generate in the years ahead, or the cash it’ll return to shareholders through dividends and stock buybacks. These analysts will then apply a discount rate to the figures for later years because $1 of profits or dividends five or 10 years from now isn’t as valuable as $1 today. They’ll then add up this stream of discounted future earnings or future cash payments to shareholders, and that gives them a company’s intrinsic value.
So, what happens to a company’s intrinsic value if it gets hit with a big economic slowdown or a serious business problem that wipes out all profits for, say, the next three years, thus nixing the company’s ability to pay dividends and buy back shares? Remember, we’re talking here about a financial debacle—no corporate profits for three years—and yet, depending on the assumptions used, the company’s intrinsic value might drop less than 10%.
Meanwhile, in a typical bear market, share prices nosedive an average 35%. In other words, when the news turns bleak and investors freak out, share prices tend to fall far more than the decline in intrinsic value would justify. In fact, judging by the size of the typical bear market decline, it seems investors are effectively assuming that the bad news might last for perhaps a dozen years.
Can’t imagine the world’s companies failing to generate any earnings for a dozen years? When the broad market plunges, maybe what we’re seeing is an overreaction—and what we’re getting is a great buying opportunity.
4. Making hay. Where does that leave us? It’s hard to figure out whether stocks are objectively cheap or not, but it seems that share prices tend to overshoot both on the way up and on the way down.
As I’ve argued before, I’m not inclined to lighten up on stocks when the market appears overheated, because there’s no limit to how high share prices might climb. But it’s a different story during declines: Shares can’t lose more than 100% of their value—and, unless the world suffers economic Armageddon, they won’t.
That’s why I invest more in the broad market whenever there’s a steep drop. No, I don’t try to figure out whether stocks are objectively cheap, because I’ve learned market yardsticks can’t tell us where the market is headed next.
Instead, I simply take my cues from the magnitude of the market’s decline, and the bigger it is, the more enthusiastic I am about buying. That might sound naïve. But after decades of investing, buying aggressively during a bear market—coupled with leaning heavily toward stocks and favoring index funds—are the only ways I know to get an edge.
Jonathan Clements is the founder and editor of HumbleDollar. Follow him on X @ClementsMoney and on Facebook, and check out his earlier articles.
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Point #1, interesting choosing 1987. Were the warnings you mention on market over-valuation before the crash of 1987 or after? I tend to agree with your statement but wonder if the warnings were before or after the crash….maybe both? I have seen this post 2008 and continue to hear it from people I truly respect as critical thinkers but I now start to roll my eyes listening to the market being 200% over-valued and we have yet to regress to the mean…yada yada yada. Now that I have posted this note, I have just confirmed that a market crash is now guaranteed to happen….I have that effect! 🙂
I remember warnings about market overvaluation prior to 1987 — but I also remember plenty of dire predictions after Black Monday about how the 1987 crash was going to spiral into a 1930s-type of crash.
Thanks Johnathan!
I have been reading this author since my 20’s. He was a syndicated financial columnist for the St. Louis Post-Dispatch (back when every Sunday it had a solid 4 pages of financial info). He was the columnist who wrote for the small individual investor.
I give Clements partial credit for how I have built my portfolio.
Thanks J Clements !
Me Too! The Post sucks now. Embarrassing.Pulitzer would be ashamed. They can’t even afford to have daily colored funnies anymore! Be prepared for them stop printing on Tuesdays!
A clear, common sense, easy to understand article. Most of these points are agreed upon by HD readers and should be shared with everyone
Once again so beautifully said and full of wisdom. The family knows I love studying the markets. When I tell them I don’t know the direction of the market in the next week they think I’m nuts. When I tell them that since they are contributing to their retirement plans that they are making the most money when the market is headed down they KNOW I’m nuts. Thank you Jonathan.
Jonathan, I support the idea of buying during market downturns, but how, exactly, do you do that? Doesn’t that require keeping a lot of extra cash (“dry powder”) on the sidelines? Does the gain from “buying the dip” in this way make up for the cash drag on one’s portfolio?
Quick second to say thank you. This is my first time posting. I’ve been a subscriber to your newsletter for a long time, and I have benefited richly from your writing.
Suppose your asset allocation calls for 60% stocks and 40% bonds. I wouldn’t consider it a terrible sin to go to 65-35. You might also take other steps, such as increasing your savings rate or halting extra-principal payments on your mortgage, so you had more to invest in stocks each month.
In the situation of a retired person with a Roth IRA, bringing more cash into the account is not practical in many cases (unless one has additional earned income). This begs the question, what are the chances of ‘dry powder’ can overcome lost potential gains? Is it simply a matter of whether the market fluctuates up or down?
You could move more into your Roth — by converting part of your traditional IRA. That would, of course, trigger a tax bill, but also increase the after-tax value of your portfolio and thus potentially mean greater exposure to stocks.
I like that thinking, so much so that I’ve already converted all of our traditional IRAs to Roth (over several years). Paid a couple heavy tax bills, but I sleep well and have greater freedom (no RMDs, no legacy taxes). I do keep some cash set aside in the Roth(s) for buying in downturns (like today!). However, I’m targeting the Roths for long term growth, so I wonder if I’m being too conservative with the cash. Then again, it’s hard to think that the market is ‘cheap’ when it’s at/near an all time high. Thanks for your help Jonathan. You’re a Blessing.
This post cuts through the crazy with brilliant clarity.
So helpful as usual. My New Year’s Resolution: Pay much less attention to my portfolio. Check in, say, once a month.
Wonderful wisdom from the master. I’ve learned that I cannot predict the future. Worse yet, I can’t even explain the past. US stocks gained 21% in 2020 as COVID hit and horrible news was everywhere. I’ve yet to see a good explanation as to why.
Beautifully said
Thanks Jonathan. The financial crisis of 2007 and subsequent market declines happened to coincide with our youngest son graduating from college and setting off on his own. We were able to max out retirement savings during those “market bargain” years. We always saved and investing, but increased the amount once college expenses were done. By automating our savings we naturally picked up extra shares as the markets declined.
This is so good.
I have known all this for years, and yet, being human (damn), I still find it difficult to stay the course.
So, this article is a keeper. I think I’ll print it out and staple it to my forehead.
Thanks.
For my wife and I, the value of our stock index funds is the present value of all future dividends. For our kids the value is the market price on the day the last of us dies.
Do you believe that gold has intrinsic value? Equities have less value than this.
My car has the intrinsic value to get me from point A to point B while I listen to the radio. I can’t use gold or equities for anything useful.
I think of equities as part of the collective hallucination we call money. It’s interesting that so many have soaring values when they don’t return dividends. Arguably, bonds have more value because they promise to pay something.
But stocks are the game. Where I am with you 100% (well, more like 50%) is being in this game.
I suggest you review the financial meaning of a stock (maybe ask ChatGPT what a share of stock means). Because you clearly do not understand equities and why they have value.
Yet another fantastic article, Jonathan. For many years I’ve revered your insight.
Your take on market dips just makes perfect sense. There inevitably are rebounds, yet so many become fearful to buy. I’m sure virtually everyone on this forum has benefited from staying the course and employing dollar cost averaging approaches. Just don’t check your portfolio for a while! (Easier to do that while you’re still working.)
The paradox is that rationality and irrationality of the market. Years ago a radio piece I was listening to in the car mentioned a stock had dropped after beating expectations. The explanation-it hadn’t beaten them by enough. I‘m still incapable of wrapping my head around that.
Yes, “there inevitably are rebounds”. However, a quick look at 1929 and the following years will show the “rebound” took more than 15 years!
I’m told if you include dividends paid, the rebound from 29 took 9 years.
“That’s why I invest more in the broad market whenever there’s a steep drop.”
I have used a market correction, ie a 10% drop from the most recent high, as signal to invest extra cash. I don’t consider it market timing, but an objective sign that stocks are on sale, and eventually the market will recover. Whether it takes 1 month 1 year or more, or the market continues to go lower after I buy doesn’t matter as I’m buying and holding.
The COVID market was a fire sale.
Where does this “extra cash” come from if it’s not already set aside for this purpose? When the market’s at it’s peak (as it is now), would 35% be appropriate?
My biggest buy was during COVID. A big part of investing success is luck.
In January of 2019 I inherited a significant amount of money from my parents. At the time I kept my powder dry as I thought the market was too “frothy” (I think an investing term coined by Federal Reserve Chairman Alan Greenspan).
I made a series of significant purchases as the market sank. I dipped my toe in the market when the market hit the level of a correction (a 10% drop from the most recent market high), invested slightly more than six times that when it hit bear (20% drop) level, then smaller amounts until it hit it’s low of a 35% drop. My final buy was four days before the market hit its low point on March 28. I purchased most in small tranches as I did not know when it would hit its low. I bought big at the bull level because that was only experience with a maximum market low.
During normal market drops when they hit correction/bull levels and rebalance to my allocation percentages, and the money comes from my bond position which is then too high, while. My stock allocation is too low.
I always believe the markets will rebound. I just make sure I have 10 years of withdrawals in cash/bonds.
I meant I bought big at the bear market level, not bull.
It could be your normal asset allocation, and a rebalance could take from cash and bonds to invest in stocks. For me 35% would be too much cash, but hopefully you’ll also have the bonds to sell.
March 2020 was quite the Blue Light Special — for the broad market and any slice you’d choose, as was late 2008 to March 2009. They are few and far between.
You’re very smart to take that approach, and have that self discipline. So many don’t. And sadly many sell and cement their losses.
As Buffet said years ago (and I paraphrase), “Why is nobody buying, everything is on sale?”.
Jonathon, you make it all seem simple yet you remind us that it is not easy.
Buying during a bear market has been the best investment I have ever made, but I remember how hard it was to buy when everyone else seemed to be selling.
Nothing to disagree with here. Thanks Jonathan.