Time in Stocks is More Important Than Timing Stocks

  by Brad M. Weafer, CFA | Chief Investment Officer

A striking feature of recent stock market activity has been an abundance of large single stock declines while the major stock market averages have exhibited relative resilience. To illustrate the point, the S&P 500 index was down 8% through February 17, 2022, but 67% of S&P 500 constituents were down more than 10%, and 52% down more than 20%. Liz Ann Sonders of Charles Schwab has been reporting regularly on this inconsistency. Figure 1 below highlights the divergence which is even more pronounced in the growth and technology-heavy NASDAQ and small company index, the Russell 2000. As you can see, a significant percentage of individual stocks has already experienced a bear market (defined by a fall from the recent high of greater than 20%), while the major indices experienced a more muted decline.

Figure 1.

This kind of stock behavior is both uncomfortable and uncommon. An analysis done by research service SentimentTrader (see Figure 2 below) highlights the infrequency in which large-scale single stock declines occur outside of major market events. Their study finds that over 1,600 individual stocks in the NASDAQ composite are down by greater than 50% from most recent highs. In other words, major single stock declines are much more prevalent today than one might expect outside of major bear markets (the Tech Bubble Crash, the Great Financial Crisis, and the Covid 19 Pandemic).

Figure 2.

Boston Financial Management portfolios are not immune from this historically odd phenomenon. We strive to own wonderful businesses that earn attractive profits and generate compelling equity returns through full market and economic cycles. From time to time, however, we will own stocks that go through periods of poor performance. How we handle those periods is important. The practice of active investing requires us to judge whether the reasons a stock is behaving poorly adequately reflect the value a company can deliver long-term. To be clear, this is no small challenge and never easy. There are very often good reasons short-term investors will sell stocks, prompting declines that force long-term investors to retest their convictions. The key is discerning which companies’ challenges are more serious, and then sticking with those who have durable competitive advantages and long run growth opportunities. The emotional response when a single stock underperforms is particularly hard to contend with, and requires extra diligence and research to ensure the long-term thesis is intact. As you might imagine, the stocks that are doing poorly in the short-term generate the lion’s share of client questions. We welcome those questions. We have a responsibility to constantly assess the validity of every investment. We classify ourselves not as investors that blindly buy and hold but instead as investors who buy and constantly challenge our assumptions and thinking.

Having said all that, a review of history suggests the need for a willingness to be patient with investments through the ups and downs. Earning solid returns over time requires a capacity to endure discomfort and hold through difficult periods. This is especially true for taxable investors, where significant value can accrue by compounding wealth over time and deferring capital gains on individual stocks.

Several case studies illustrate this point effectively. If you asked people what the best-performing stocks in the S&P 500 were over the last 30 years, many would point to Amazon, Apple, or a similar innovative company. The best performing stock was classified as a consumer staples company, Monster Beverage, which earned a whopping 30.6% per annum between June 1992 and January 2022. To illustrate the value of compounding, this means that $10,000 invested in Monster 30 years ago would be worth $27 million today! It might surprise you though, that investors had to endure three declines of more than 50% during that time, including a near 90% decline in 1996. Figure 3 shows just how much volatility a patient investor went through to earn that exceptional return. Holding on to a stock that is down over 50% requires significant conviction and patience; in this case, the results were wonderful. More well known is Apple, the largest company in the world and the tenth best performer of the last 30 years (21.8% per year). Despite such an enviable reputation and long-term record, the stock went through seven declines of over 50% since going public, including falling more than 80% twice. It is not just the dramatic 50% drawdowns with which investors must contend. Many great companies must endure almost consistent volatility on their path forward. Take Amazon as an example. The company’s stock has had an average annual drawdown of 33% per year, which occurred at the same time it compounded at 35% per year since their IPO in 1997. They too had to contend with a thesis testing peak to trough decline of over 94% at one point. Those that held through that decline were likely ridiculed and heavily questioned at the time. They are likely no longer questioned on the wisdom of their investment choice.

Figure 3.

We recognize these are dramatic examples that worked well. We acknowledge and appreciate not all stocks that experience material drawdowns turn out as well as Monster, Apple, and Amazon. These are extreme examples, but almost no great investment comes without challenging periods of poor short-term performance. An oft-used market adage suggests an investor’s time in the market is more important than timing the market. That guidance also holds very true for individual stocks, and the lesson is worth remembering during volatile episodes like we are experiencing today. We can commiserate how difficult it is to endure these instances, but in investing, patience is required and often rewarded.

The team at Boston Financial Management is always available to answer your questions. Please do not hesitate to contact your Wealth Manager directly or call our main line at 617-338-8108.