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How to start investing on the market that has been growing for 9 years..

28 May 2018,

Stock markets have been growing in the US for 9 years. The question is how long they can grow. We have partly touched this question in the article about market valuation. Today I will focus on the beginning investors who want to invest funds now, and they may be afraid that the market will drop down and they will lose their finances in the future.

 

 

Some statistics at the beginning

Between the period 1929 to 2009, there had been 14 recessions in the US. The recession is defined by the moment when the real GDP is falling at least two consequent quarters. The long recession is called economic depression (see 1929).

Average recession time was 9 months and the average time to another recession over 4 years. And the current 9-year bull trend looks unstoppable. You would probably expect that the stock markets will decline in recession. But here you would be wrong. We know from history that in the half of such cases, the S & P500 index has been growing. Yes, this was really happening during some recessions. Source: http://www.nber.org/cycles.html

You can see in the figure bellow that there were situations where the index showed growth (orange strips indicates recession):

bearsbulls

Source: https://www.ftportfolios.com/Common/ContentFileLoader.aspx?ContentGUID=4ecfa978-d0bb-4924-92c8-628ff9bfe12d

So if the new investor would like to passively invest in the asset that copy S & P500, he has a 50% chance that in the next recession (we do not know when it will come), the index will have a negative return.

Cost averaging

If a new investor invests on the peak of the economic cycle and the start of the recession, he may lose significant part of his capital. The method that can help an investor is called the cost averaging. Regularly, for example, every month, he purchases a certain asset (in our case, S & P500). Below you can see how it will develop compare to one-time investment:

Cost averaging before the crisis

 

Within a few years, you can see that a one-time investment is profitable. Averaging costs are therefore a very good tool to divide investment over time and avoid short-term losses. If someone argued that the decline could be longer, have a look at the lost decade in Japan until 2017:

Cost averaging for Lost Decade in Japan

prumerovani nakladu

Free cash flow, dividends and repurchase

Passive investing in indexes has both its advantages and its disadvantages. Of course, another strategy can be chosen- selecting quality companies with sufficient free cash flow, dividend payments and repurchase plan. Why this combination? If there is a recession that causes a drop in sales and in corporate profits (if not bankrupt of smaller companies), it clears the space to larger companies. Companies with free finances can use this money, for example, to buy a competitor or a smaller company that is nod doing so well and is just surviving. Repurchase reduces the availability of market shares and creates conditions for the growth of the value. Dividends are source of good returns, even in times of recession. If the investor does not want to look for a high-quality company with given features, he can also choose the MOAT ETF ticker.

Conclusion

The economy works on the basis of recession and expansion. When the recession approaches, investors rebalance their portfolios – they are getting rid of risky assets and buy those that are less inclinable to recession. They can insure themselves with gold, which is a safe harbor in the turbulent waters of stock markets. However not always  recession markets are declining. A new investor on the 9 years growing market must pay attention, he can help himself with the cost averaging or looking for quality companies with competitive advantages. However, any investor should not definitely put everything on one card, diversification is the basis. When exactly the recession comes we do not know, we are not a prophets. Such people will come back at the beginning of new year when they take their crystal balls out to tell us how the 2019 will be. And when the recessions comes and the markets fall? We’ll go to purchase some companies.

 

PS: This is not an investment recommendation, only the author’s personal opinion. Invest with your reason not by emotions.

 

 

 

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