Periods of high volatility in the markets are inevitable, as are those times when the sharp oscillations trend downward. Case in point: Last week, over the course of Wednesday and Thursday, the S&P 500 lost around 5% of its value. But don't panic. After a bull market cycle has run as long as this one has, and with unemployment low and GDP growth strong, it's natural that interest rates will finally inch up from the extreme lows they landed at after the financial crisis.
In this segment from Motley Fool Money, host Chris Hill and senior analysts Ron Gross, David Kretzmann, and Jason Moser discuss the bigger macroeconomic picture, momentum stocks, risk, bargain shopping, and how Foolish investors should respond to this dip -- advice that's especially useful for people who haven't been in the stock market through prior bearish periods.
A full transcript follows the video.
This video was recorded on Oct. 12, 2018.
Chris Hill: We begin with the market's wild ride. On Wednesday and Thursday, the S&P 500 fell more than 5%. The Dow Jones Industrial Average lost around 1,400 points. Everyone was freaking out, Ron. Friday morning, the bleeding appeared to stop, the market bouncing back a little bit. There's a lot to unpack here. How'd you do this week?
Ron Gross: Stop me if you've heard this one before: these things happen. We're at the end of a nine-year bull market. We've got extremely low unemployment, high GDP, low interest rates for forever, a really long period of time. At some point, folks, inflation ticks up, interest rates rise, stocks correct. It's actually quite healthy. It might be painful. Listen, I don't like to see my stocks go down, but it's actually quite healthy. If you don't panic, you stay the course, you think long-term, you can actually benefit from it.
Hill: Jason, around the office this week, there's been a lot of quoting of David Gardner, co-founder of The Motley Fool, who said, "Remember, markets go down faster than they go up. But over time, they go up more than they go down."
Jason Moser: Yeah. It feels like they've been doing nothing but go up for a really long time. This is sort of a nice reminder that they do indeed go down, and life indeed does go on. We were talking about this earlier this morning, I think that one of the biggest benefits from coming out of the financial crisis, if you were an investor and you went through the financial crisis, then this is the kind of thing where you can just brush right off your shoulder and keep on moving along. You understand what's at stake here. This is why we invest the way we do. You can't predict when stuff is going to happen. There's not necessarily a rationale for what happened. But it does happen, and you need to be able to maintain your composure, understand that you're going to have some bumpy rides along the way. But, again, when you look at five, 10, 15, 20-year time horizon, the market clearly trends in one direction, and it's not down.
Hill: That's the thing, David. There are a lot of investors who really just started in the last seven, eight years or so. They've never dealt with something like this.
David Kretzmann: This week is a helpful reminder that stocks do indeed sometimes go down. But at the same time, you do have to take a step back and keep this in perspective. The S&P 500 has just fallen back to where it was in July, a few months ago. Obviously, it hurts to see your money go down more than it feels good to your money go up. We tend to react in a sharper way to pain rather than the joy of gain. Really, this comes down to the psychology of investing. When you can keep that long-term time horizon in mind, just remember that the longer you hold, the higher your odds of success over time. There's never been a 20-year stretch with the S&P 500 where you actually would have lost money. And that's going through the Great Depression, the Great Recession, multiple wars, and all sorts of other macro events and worries. The longer you can hold your stocks, and the wider your time horizon, the better off you'll be as an investor. It doesn't take away the pain that you see in a week like this, but with that kind of perspective, you treat a drop like we've seen this week as more of an opportunity rather than something to fear.
Gross: I think it's also important to note that the stocks that have been the highest flyers are the stocks that have come down the most and actually have a bigger impact on the S&P 500 because of how much they've grown. I'm thinking largely about the tech stocks, stocks that you'll often hear called momentum stocks. By the way, if you buy a momentum stock, you'd better understand that momentum goes both ways. [laughs] What goes up does come down. Common physics tells us that. Hopefully, they go up more than they go down.
When these stocks that have been on a tear come down, they come down rather severely. That can create an opportunity to pick up shares as they get cheaper, if you have the stomach for the volatility. Sometimes I see people jumping in a little too soon. They see one day, a company dropped 2%, and they say, "Oh, time to get in, 2% down!" When, in the scheme of things, the stock is up hundreds of percent to that point. 2% is nothing. But, it's important to see what pockets of the market are really bringing the market as a whole down.
Moser: Yeah. I think it's really easy to get into a situation like this and get nervous, particularly if you're relatively new investor. We like to quote Warren Buffett all the time here. There is one quote, I'm going to push back on him a little bit. He said something to the extent of, "Diversification is for people who don't know what they're doing," something to that effect. I get what he's saying there. He's like, "If you know what you're doing, then really, you can go ahead and concentrate your bets and feel good about how you're investing." I think, for the most part, people need to focus on diversification. This is a great example of a time where diversification can help combat the emotions that you likely feel in volatile times like these.
We invest a certain way, obviously, long-term in mind. We have a lot of those growth names in our portfolio. And a lot of that growth has been pulled forward to these valuations today. To see them take a hit is not surprising. But if you have some nice, staid dividend aristocrats, for example, in your portfolio to help counter those high-growth names, then this volatility becomes a lot easier to stomach.
Hill: That was one of the things we talked about last week, Ron. We're seeing interest rates going up, we're seeing 10-year Treasuries at a seven-year high. Another thing we talked about this morning was the speed. It's not just that the market is going down, it is the speed with which we're seeing these drops. I have to believe that at least part of this is that rise in interest rates, and the relative attractiveness of stocks going down ever so slightly.
Gross: For sure. Interest rates are a very, very big part of this. Not only do higher interest rates to make borrowing costs for companies higher, which lends to them having declining profits as a result of increasing costs; but higher interest rates create alternative investments that make the stock market perhaps less attractive than it looked when interest rates were low. If you can earn 3% on a risk-free 10-year U.S. Treasury, maybe you don't want to own a 2% dividend stock; unless, of course, you think there's appreciation potential on top of that to be had. But you start to think about it a little bit and do the math. Certainly, a subset of investors say, "I'll take the 3.5% safe money."
Kretzmann: I think rising interest rates impact shorter-term investors or traders more than it impacts Fools like us, who have a long-term time horizon. We're often investing with the intent to hold these companies for at least five years, and ideally, you'd have 10, 20, 30 years. In the grand scheme of things, where interest rates go from one quarter to another, one year to another, probably doesn't matter as much when you're thinking in terms of decades, not quarters or years. But at the same time, you're seeing all the talking heads on CNBC and TV who do often have a shorter-term time horizon. That's all they talk about. You can't just ignore it. But keep that longer-term picture in perspective. I think the interest rates turn out to be more noise, when it comes to the individual companies in your portfolio.
Just to double down on something that Jason mentioned about diversification, you have to remember that the volatility that we've seen this week is the norm, not the exception, when it comes to the stock market. Build your portfolio accordingly. Position your portfolio in such a way that you can kind of ignore this inevitable short-term volatility as best you can. Keep that long-term time horizon in mind. For some people, that might mean having a little bit more cash on the side to take advantage of market declines like this. It might mean diversifying into some more stable companies, like Jason mentioned. Whatever it is, you want to build your portfolio in such a way that you see this inevitable volatility as an opportunity, not something to worry about.
Gross: I'll just say that during times like this, you often hear criticism of the Fed being too tight on monetary policy, or whatever. They're always to blame. I would recommend to Foolish investors to turn that conversation off in your head. Focus on the companies you own, the companies that you think are great for the next five and 10 years. Let the Fed do whatever the Fed is going to do. It's out of your control anyway. Just stay as a long-term investor.
Hill: It's kind of laughable when you consider that a few years ago, the Fed was being criticized for cutting rates.
Gross: [laughs] Right. They can't win. It's a miserable job.
Hill: Yeah. Sorry, you can't have it both ways. You can't say the economy's the strongest it's ever been, and then in the next breath, say, "But please don't raise interest rates a 15%, because we're so fragile we'll just be destroyed." I should point out that we are taping this in the middle of the trading day on Friday. While the market was up in the morning, who knows where it'll end up? Fingers crossed it ends in the green.
Let's just go around the table. One of the things that we talked about in our planning meeting this morning was, we were kind of hoping to see a little bit more of this. And who knows, depending on how next week goes, maybe we'll get more of that. We're looking for opportunities, particularly if you've got a little cash on the sidelines, if you've got a watch list. By the way, this is why we do stocks on our radar. This is why we have a watch list.
Ron, I'll just start with you. What's a company that you've got your eye on that, if it fell 20% next week, you wouldn't be too upset?
Gross: People think we're disingenuous when we say we wish the stock market would have kept going down, but really, it's true. I've had a lot of cash on the sidelines waiting for opportunities like this. I'm under-allocated in some of those high-tech stocks I mentioned earlier. I'd love to get in on them at cheaper prices. 20% lower would be awesome. A company like Twilio, TWLO. They make applications that arm developers with the tools to embed communications like text, voice and video. Facebook's WhatsApp uses Twilio's applications. I'd love to be an owner of that stock, but at the right price.
Moser: It was an easy one for me. I'm already an owner of Idexx Laboratories, ticker IDXX. I would certainly love to pick up some more shares at a cheaper price. Idexx is the market leader in the pet diagnostics, equipment, and testing market. They get a lot of those big razors, the equipment, into veterinarians' offices, and then they sell those blades, the consumables, in the form of those diagnostic tests and whatnot. I have a veterinarian that uses all of their stuff, swears by it, and my three dogs at home seem to be very happy and healthy, Chris. So, I'm going to take his word for it.
Kretzmann: I'm looking at Match Group. Kind of in a similar boat to Ron here. This has been a high flyer. It's been an incredible stock. Still trading for close to 40X forward earnings. This is a company behind a portfolio of dating sites and apps like Tinder and its namesake Match. This is really getting to be a business that's printing cash. Free cash flow has more than doubled over the past four years. Expanding globally. They have a subscription model that they're rolling out with Tinder that seems to be doing really well so far. Finding ways to increase user engagement both in North America and around the world. That's one I'm keeping an eye on.
Gross: I'll just add, the first thing I did when the market started turning south is, I checked our internal system to see if I was cleared to buy the S&P 500 and the Russell 2000. Nothing wrong with buying an ETF, a broad-based index.
Hill: With a nod toward a theme we've talked about for a while now, the war on cash, I will simply say that I would not at all be upset if Visa and MasterCard had really bad weeks.
Chris Hill has no position in any of the stocks mentioned. David Kretzmann owns shares of FB, MA, MTCH, and V. Jason Moser owns shares of IDXX, MA, and V. Ron Gross owns shares of FB and MA. The Motley Fool owns shares of and recommends FB, IDXX, MA, and TWLO. The Motley Fool owns shares of V. The Motley Fool recommends MTCH. The Motley Fool has a disclosure policy.