5 Things to Remember as the Market Gets Wild


Stocks up 150 points in the morning, down 150 points by lunch, somewhere in between by close. That was the stock market Monday, all whipped around by one of the most bizarre debates imaginable: whether Congress will intentionally default on the national debt.

Oh, and the economy's a mess. Growth in the first half of the year slithered near zero percent. What looked like decent growth over the past two years was revised down to bupkis. Jobs? We used to have those. Optimism? Gone.

Scary days, these. And with scary days comes the visceral response of wanting to do the ostrich -- head in the sand. Rather than dealing with market volatility, the temptation to sell everything and avoid it grows unbearable for some investors. Last week, analyst Dick Bove recommended investors abandon the market and sell all their stocks. I said that was terrible advice. Similar calls are gaining momentum this week. No fewer than four guests on CNBC this morning recommended selling stocks while waiting to see how things pan out. This, too, is terrible advice. Here are five reasons why.

5. The big moves happen during the darkest days.
This was my beef with Bove's call. Since 1928, missing just the 20 best market days cuts total returns in half. Moreover, every one of those best days occurred during periods of market chaos -- all within days of some of the market's worst sessions. This is when those who try to time the market often get destroyed. Try avoiding the big drops, and you'll almost certainly miss the big gains. The result is usually mediocrity at best and more often an exercise in wealth destruction. How many people sold when the Dow was at 10,000, thought they were brilliant as it fell to 6,000, and stood in disbelief and denial as it rallied back above 12,000? More than you think (and more than admit it).

4. Those who trade the most do the worst.
This one's related to the last point. The Journal of Finance once published a study showing that those who trade the most earn the worst returns. Households whose portfolios had 20% monthly turnover underperformed market averages by nearly 6% a year. That underperformance is simply devastating over time. "Our main point is simple: Trading is hazardous to your wealth," the study concluded. Check your confidence at the door if you think you can sell now and get back in when things get better without underperforming market averages. The number of those succeeding at this in the past is likely what you'd expect from random chance.

3. You want to be invested when stocks are cheap. And many are.
If you're eager to sell stocks because you think they're overvalued, by all means, do. That's when you should. It's when you sell stocks just because you think they'll go down that's dangerous.

Many -- maybe most -- stocks are not overvalued today. I've highlighted companies like Microsoft (NAS: MSFT) , Google (NAS: GOOG) , Apple (NAS: AAPL) , and Berkshire Hathaway (NYS: BRK.B) , which trade at or near some of their lowest valuations ever. Even looking at broad market indices, it's hard to play the overvaluation card. The S&P 500 trades at 14.3 times trailing earnings. The average since 1988 is 19 times earnings.

Could earnings fall as the economy stalls? Of course. Just don't forget ...

2. Domestic stocks are anything but.
Nearly half of all S&P 500 revenue comes from outside the United States. BlackRock's Robert Doll reckons that 70% of incremental earnings growth over the next five years will come from overseas. Yet investors pondering the course of the stock market focus almost entirely on the U.S. Why? I spoke with someone last year who sold his U.S. stocks because, in his words, "China was running laps around the U.S." I argued that this was a reason to own U.S. stocks. Slow growth in the U.S. can be offset by blistering growth in China and Latin America. And it is. It's a major reason U.S. corporate profits are at record highs and growing briskly while our economy flatlines.

1. The future isn't predictable.
This is the most important reason it's foolhardy to sell in anticipation of trouble: You simply have no idea what the future holds.

Here's a test you can do. Use Google Archive to go back in history and read old newspapers. See how many people really saw the future as it panned out without hindsight bias. Go back to 2006 and see how many CNBC guests predicted Citigroup (NYS: C) would fall 98%. Go to March 2009 and look for those who thought markets were about to double. Go back to 1991 and see how many economists predicted one of history's largest booms was around the corner. Very, very few.

And the ones who did -- the analysts who became (or are currently) rock stars -- statistically end up making the worst predictions after rising to fame. Philip Tetlock of U.C. Berkeley has done phenomenal research on expert predictions. His conclusion: Those with the most media appearances make the worst predictions, and overconfidence from past predictions undermines the accuracy of future ones. Random luck, it seems, plays a role in the success of those we call seers.

Better yet, use Google Archive to immerse yourself in the abundance of past gloomy calls that never came true, or came and went without fanfare. If there is predictability to the future, it's that, broadly, economies adapt, capitalism works, and this too will pass -- yet the masses will think otherwise. Pessimism is one of the most prevalent attitudes in a world where progress has, over long periods of time, marched consistently higher. Think about that before you sell.

Check back every Tuesday and Friday for Morgan Housel's columns on finance and economics.

At the time thisarticle was published Fool contributorMorgan Houselowns shares of Microsoft and Berkshire Hathaway. Follow him on Twitter @TMFHousel. The Motley Fool owns shares of Berkshire Hathaway, Google, Microsoft, and Apple. Motley Fool newsletter services have recommended buying shares of Berkshire Hathaway, Apple, Google, and Microsoft, as well as creating a covered collar position in Microsoft and a bull call spread position in Apple. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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