Since mid August, the stock market has fallen 7.3%, and that has investors wondering if they should be getting greedy now that others are getting fearful -- an investing axiom popularized by the world's best investors, both past and present, including Cornelius Vanderbilt and Warren Buffett. Recently, fellow Motley Fool John Maxfield reminded us how Vanderbilt's bargain-hunting savvy made him one of America's richest Americans, and Buffett's buy-low exploits, including money-making lifelines given to big banks during the Great Recession, are well chronicled.
But what often gets overlooked when markets slump is that corrections are far more common than the buy-the-fear moments that made Vanderbilt and Buffett legendary. For that reason, it makes far more sense to stick with a long-term plan rather than try to time the market
How much fear is there, really?
Some of the savviest be-greedy-when-others-are-fearful dealmaking has been done when fear was so heightened that a falling market was accompanied by rock-bottom valuation measures, soaring short interest, a shrinking economy, and a massive liquidity squeeze. That's simply not the case today.
The S&P 500's P/E ratio remains elevated relative to historical levels. The economy is growing, not receding, and levels of short interest -- a measure of how pessimistic people are about the market and the economy -- remain off its peak.
Just how pricey the S&P 500 is depends on whether you use the more traditional "divide price by the trailing 12-months of earnings" method, or the 10-year cyclically adjusted P/E ratio fathered by economist Robert Shiller. Currently, the traditional P/E and Shiller P/E stand north of their historical averages at roughly 20 and 25, respectively, so neither is flashing a resounding "buy the fear signal." Similarly, short interest, or the number of days of average trading volume necessary to cover all shares held short, remains timid relative to the past for many companies, including high-flyers such as Netflix, which had a short interest of 3.19 days last December, but sports short interest of just 1.78 days as of August.
The economy and the liquidity spigot aren't indicating we're at a get-greedy point, either. U.S. GDP grew by an annualized 3.7% in Q2, and the nation's unemployment rate is a non-worrisome 5.1%. Last month, 41 states and DC saw their unemployment rates fall, rather than climb, and that's hardly the kind of data you'd expect to see at a buy-the-fear moment, especially given that the Federal Reserve's August survey of senior bank loan officers shows that credit standards are still easing, rather than tightening, across most loan categories.
Overall, these points indicate that this isn't the kind of fear-driven market that would find Vanderbilt or Buffett shooting at fish in a barrel, but is, instead, the type of market that is, at best, experiencing a normal -- albeit painful -- correction, or at worst, is prepping for a far bigger move downward.
It's all about perspective
The potential for further losses is scary, but only if you're thinking short term, rather than long term. Since 1950, the S&P 500 has fallen by 10% or more 33 times, according to Standard & Poor's, and in every instance, markets have gone on to reverse their losses and make new highs.
Although the past isn't prelude, that track record suggests, regardless of the magnitude of a drop in the markets, that it makes more sense to spread your buying out over time rather than attempt to guess when fear is telling you to go all-in and buy stocks. Embracing long-term approaches, such as establishing or increasing investments into retirement accounts such as 401k plans that allow you to invest every pay period, can reduce market risk while eliminating, or at least reducing, dangerous, emotionally driven buying or selling.
Overall, creating and sticking to a strategy that involves investing consistently is likely to do better over time than a strategy relying on market timing. Knowing that can help you withstand anything that the market can dish out from here, including more fear.