The S&P 500 tumbled into a bear market last year as high inflation and rising interest rates rattled Wall Street. In fact, all three major U.S. financial indexes suffered their sharpest annual declines since the Great Recession. But the stock market may fall further in the near term. Many experts believe a recession is imminent this year.
That has worrisome implications for investors. Corporate earnings already declined last year, but a recession would put more pressure on profits, and that could very well drag the stock market lower.
Yet the worst mistake investors can make is sitting on the sidelines right now. The major financial indexes will recover when the next bull market rolls around, and missing even a portion of the rebound could be a costly mistake.
Consider this advice from Warren Buffett.
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Widespread fear creates buying opportunities
Buffett once wrote "A simple rule dictates my buying: Be fearful when others are greedy, and be greedy when others are fearful." He went on to say that investors should be leery of businesses in weak competitive positions, but "fears regarding the long-term prosperity of the nation's many sound companies make no sense."
That advice was published in The New York Times on Oct. 16, 2008. The date is noteworthy because the S&P 500 was down 40% at the time, and the investment bank Lehman Brothers had collapsed one month earlier. It was the biggest bankruptcy in U.S. history to date, and the bank's failure shook Wall Street to its core. Investors were worried that financial contagion would spread to other institutions.
Amid that chaos, Buffett provided a voice of reason, and his advice is relevant once again today. Recession fears have brought about a sweeping drawdown in the stock market. The Federal Reserve has raised its benchmark interest rate at its fastest pace in four decades, and recent bank failures could further tighten lending conditions. Those variables could certainly cause an economic downturn, but investors focused on that possibility are missing the big picture. Many good stocks are trading at significant discounts to their historical valuations, and buying opportunities like that are infrequent.
Attempting to time the market is a mistake
In the same article, Buffett explained why market timing strategies are doomed to fail.
Let me be clear on one point: I can't predict the short-term movements of the stock market. I haven't the faintest idea as to whether stocks will be higher or lower a month or a year from now. What is likely, however, is that the market will move higher, perhaps substantially so, well before either sentiment or the economy turns up.
Buffett's claim is backed by historical data. The S&P 500 started its rebound before economic activity bottomed in every recession during the last 50 years, with one exception, according to JPMorgan Chase. That means investors sitting on the sidelines today will likely miss a portion of the rebound. Or, to borrow a folksy metaphor from Buffet, "If you wait for the robins, spring will be over."
Grab the washtub -- the economic skies are raining gold
In the last two decades, 42% of the S&P 500 index's strongest days occurred during bear markets, and another 34% took place during the first two months of a bull market (i.e. before it was clear the previous bear market had ended). Missing even a few of those days can do lasting damage to a portfolio.
According to Putnam Investments, the S&P 500 produced a total return of 255% during the 15-year period that ended in December 2022. But if the 10 best days are eliminated from the equation, the total return drops to 62%. And if the 20 best days are excluded, the total return is negative. In other words, investors pay a high price for avoiding stocks during bear markets.
I'll close with a final bit of folksy wisdom from Buffett: "Every decade or so, dark clouds will fill the economic skies, and they will briefly rain gold. When downpours of that sort occur, it's imperative that we rush outdoors carrying washtubs, not teaspoons." A decade down the road, I believe investors that look back on the current bear market will realize the skies were indeed raining gold. Buffett seems to think so, anyway. Berkshire Hathaway purchased nearly $68 billion in equity securities last year, more than it invested during the previous three years combined.
