In my 28 years on Wall Street I’ve lived through over thirty stock market corrections worldwide. Not once have I been able to call a market bottom. I gave up trying long ago and it has not hurt my performance at all. Here’s why.
The truly deep market declines (like the one we are now experiencing) make calling a market bottom unnecessary. In my experience, whenever any stock market has dropped by over 50%, I begin to invest. I figure I can’t go wrong with a “half off sale” even if prices decline by another couple of percent. To my way of thinking, I’m still getting a deal especially if I plan to hold my investment for the next few years.
That’s not to say you should put all your cash to work immediately. Instead, I suggest you use a time- tested method of investing called dollar cost averaging. It works this way: let’s say you have $12,000 to invest, take the first third of that sum ($4,000) and buy your stock or mutual fund this month. Add another third in January and the final third in February. This type of investing works well especially in volatile markets and usually produces the best entry level prices. If you are super cautious invest one third every three months.
Stock valuation is also a better way of buying stocks then trying to pick a bottom. I use the price/earnings ratio (among others) as a measure of determining how cheap stocks really are. Last month the S&P 500 benchmark index traded at roughly 10.4 times earnings which is the lowest it’s been in over 50 years. Could stocks go even lower? Sure, they could but they are cheaper now then at any time since I came into the business.
Another factor that has always been present in severe market corrections is an overwhelming mood of pessimism and fear among investors. Over the last two months I could practically scrape anxiety off my office walls. I have experienced an unrelenting torrent of sell orders with practically no client willing to add money to the market. I witnessed the same thing dozens of times and learned to buy when others sell.
As for the market pundits and talking heads you watch on television, ignore them. I have lost count of the number of market pros this year who have called a bottom on this market not once, not twice but three times! I’m sure even more will jump into the act every time stocks make another move higher. If they keep proclaiming a bottom, they are bound to be right at some point.
At their lows in November the S&P 500 was down 52% and the Dow lost 47%. They can go lower if history is any guide. I remember the Japanese market in the aftermath of the bursting of their real estate bubble back in the 1990s. The Nikkei fell much further than 50% as did our own tech-laden NASDAQ market in 2003. Then there was the crash of 1929-1930 when the Dow fell by about 48%, retraced 50% of the decline and then fell almost 90% in 1930. Yes, that was an exceptional period but it certainly could happen again. So don’t put all your chips in the market at once. Dollar cost average and have patience. Over time you will be rewarded.