Volatility is the friend of the Value Investor

Volatility is the friend of the Value Investor

May 1994
Dow Jones Industrial Average 3,700
Interest rates rising rapidly. Worst year in the history of the bond market.
Stocks already up 60% from their October 1990 low. Few forecasters predicted further gains for equities.
Just 7 months later, stocks would embark on the greatest bull market run in history.

March 1998
Dow was at 8,800
The world stock market had been rolled the previous October by collapse of the Asian markets.
This precipitated a record 550-point drop in the Dow and closure of the New York Stock Exchange.
Few months later, the markets were shaken by collapse of the huge hedge fund Long-Term Capital Management.
From July to early Septermber 1998, Dow fell 20%.
The trillions of dollars of contracts held by this fund on the verge of bankruptcy threatened the functioning of financial markets, causing an unprecedented intervention by the Federal Reserve to restore liquidity.
Three quick rate cuts by the Fed restored investor confidence.
With the uncertainty surrounding Y2K less than 2 years away, few envisioned that October 1998 would begin one of the most spectacular bull markets in history.

March 2000
The technology-laden Nasdaq more than tripled, crossing 5000.
Prices of the world's largest equities surpassed 100 times earnings for the first time in the history of the markets.
Investors optimism was rife.
The Internet launched a gold rush that made instant millionaires of many workers in start-up companies who were paid with stock options.
John Doerr, a venture capitalist, called the run-up of Internet stocks the largest legal act of wealth creation in world history.
And many who missed the first round were lured into a bull market that appeared to ensure profits to all who participated.
This domestic exuberance was matched by a feeling that liberal democracies built on free markets had triumphed as a model for international development.
The entire world seemed to stand at the threshold of unprecedented economic growth, where U.S. based corporations would lead the way.
The communications revolution confirmed that the world was getting smaller and that national boundaries were shrinking.
Communism had been replaced by democracies in eastern Europe, apartheid was peacefully eliminated in South Africa, and even the Israelis and Palestinians were close to a historic peace accord.

Post March 2000
Then it all came crashing down.
The Nasdaq, which had peaked in March 2000 at over 5,000, fell by more than 70% in the next 18 months.
Internet stocks declined even further, and international terrorists launched a successful full-scale attack on the United States.
From March 2000 - September 2001, stock values, as measured by the broad Wilshire 5000 Index, fell 40% and wiped about $5 trillion from market values.


LESSONS AND CHALLENGES FOR THE LONG-TERM VALUE INVESTOR

• The public, once universally regarded as fickle and quick to abandon stocks in difficult times, stuck with equities.
• There was remarkably little panic selling by investors, and surveys showed that few lost their faith that stocks were still the best long-term investment.
• Long-term real returns on equities have averaged about 7% per year over all long-term periods.
• Even counting the bear market of 2000 - 2001, real returns averaged 11.3% per year in the 8 years since 1994.
• From the beginning of grand bull market in August 1982 through March 2000, real returns averaged 15.6% per year.
• These stock returns were significantly above the long-term average.
• Be cautious of bull market that drove investor expectations too high.
• During the bear market, many investors should not have un-realistic expectations of what the stock market can deliver.
• The lure of short-run gains, the attraction of various paradigm, and the relentless pressure to keep pace with hot sectors and hot stocks caused many investors to abandon their long-term principles.
• Real returns of 7% per year, even though doubling wealth every 10 years, is too slow for many who tasted the spectacular gains made in the bull market.
• Investment based on genuine long-term expectation is so difficult today as to be scarcely practicable. (John Maynard Keynes 1937)
• Although future stock returns may be diminished from the past, there is overwhelming reason to believe that stocks will remain the best investment for all those seeking steady, long term gains. (Jeremy J. Siegel, Stocks for the Long Run)