Investing in 2023: What a look back at history can tell us and where it points us

Investing in 2023: What a look back at history can tell us and where it points us

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After year upon year of stock market prices rising (also known as a "bull run"), 2022 was the worst year for investors since 2008. According to the New York Times, "virtually no stocks" were spared from losses last year.

Although there were many factors at play in 2022 - the war in Ukraine, the Chinese economy, the lingering effects of the pandemic - the main culprit for stock prices falling was red hot inflation, which caused the Federal Reserve to raise interest rates in an attempt to cool the economy. Rate hikes throughout 2022 drove interest rates to reach their highest level in 15 years.

Unsurprisingly, the vast majority of investors felt everything from upset and disappointment to anxiety when they viewed their paper stock market losses. If you work with a fee-only, fiduciary financial advisor whose business depends on your stock market success, they likely felt similar to you. (If your advisor is not a fiduciary, who has a legal obligation to put your interests first, you may want to consider switching to one. You might be surprised how many big brand name investment firms are not fiduciaries.)

With 2023 taking the stage, investors have some burning questions: have we hit bottom in the market, or will we hit a new low in the first quarter of 2023? Will stocks rise early this year and then fall in the third quarter? How often (and how much) will the Fed raise rates this year? How will geopolitical factors, particularly those in Ukraine and China, weigh on stocks? If there's a recession, how severe will it be?

The up and down cycle through time

While many pundits proffer their best guesses, the answers to these questions are unknowable. Amid such uncertainty, why keep calm and carry on investing? Well, don't take my word for staying in the market, let's look at history.

In decade upon decade, no matter what the terrible circumstances of the day - war, inflation, disease, terrorist attacks, recession - the markets have always recovered. This bears repeating: Always. Here's a snapshot of market disturbances in the last 30 plus years.

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Although our circumstances in 2022 were unique (e.g., supply chain snarls after a pandemic) when we entered bear territory, which is when a stock index's closing prices drop at least 20% from its most recent high, a market downturn was nothing new.

Since 1945, there have been 14 bear markets. While these markets can be painful, they are a temporary cost of doing (stock market) business, with a strong upside. After every bear market and recession, the stock market has always bounced back and produced all-time high values. If you're a long-term investor, the challenge is to learn how to weather the up and down cycle.

One fortifying fact to keep in mind is that bear markets tend to be short-lived. The average length of a bear market is close to 10 months. That's much shorter than the average length of a bull market, which is 2.7 years.

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Of course, when you're looking at losses over months without knowing when the market will bounce back (although it will), it's much easier said than done to set your feelings aside and stay in the market.

Don't miss out on market recoveries

For over 30 years, I've lived through these market cycles repeatedly and witnessed the pain of investors who panicked and pulled out of the market during downturns, which locked in their losses. Wall Street veteran Art Cashin, head of floor trading for UBS, summarized the ramifications of this type of investor behavior when he said, "Those who react immediately rarely do well."

Knee-jerk, emotionally driven decision making by long-term investors is often a double whammy: it hurts them in the short term when they sell and in the long term when they miss out on some remarkable recoveries.

A study from Bank of America, which examined data going back to 1930, found that if an investor missed out on the S&P 500′s 10 best days per decade, their returns would be significantly lower than the investor who stayed invested during downturns and didn't panic sell.

In the chart below, which looks at a hypothetical $1,000 investment in the S&P 500 between 2012 to 2022, you can see the negative ramifications of not being in the market during the best days of that decade.

[Insert CHART #3 "Missing just a few of the market's best days can hurt investment returns"]

It's also worth noting that good days don't just happen during largely good market years. In fact, half of the S&P 500's strongest days in the last 20 years occurred during a bear market.

This historical perspective offers a strong case for not trying to time the market by trading out one day and jumping back in another. As the famous investor Bill Miller put it, "Time, not timing, is key to building wealth in the stock market." After all, over the long term, the market continues to go up despite short term ups and downs.

How to handle a bear market

1. Focus on your financial plan

If you're a successful corporate executive with stock equity compensation and a more complex benefits package, you've hopefully worked with a fee-only, fiduciary financial advisor to develop a long-term financial plan that's customized to your unique situation and goals. The type of comprehensive plan that minimizes tax liabilities and contains sound assumptions about inflation and the cycles of the market.

With such a well-thought out plan that's pro-actively managed (it's not a set-and-forget instrument), history shows that it's wise not to get caught up in short-lived market fluctuations and news headlines. Instead, stay the course and focus on your plan.

2. Check you're investing in quality companies

Fundamentally strong companies with good cash flow, sound balance sheets and seasoned management teams often have lengthy track records of successfully navigating market downturns.

These Steady Eddie, higher-quality stocks might not seem as exciting as a growth stock like Tesla, but they are less sensitive to high inflation and interest rates. Over time, they often become more valuable.

3. Ensure your portfolio is diversified

At Van Leeuwen & Company, all of our clients' financial plans rest on a diversified portfolio of high-quality companies. Spreading investments across industries and countries lessens the risk of losses during turbulent economic times.

6. Examine what quality stocks are on sale

Bear markets can create opportunities for long-term investors when stock prices are often priced lower than in the past, effectively placing them on sale. This is why famed investors like Warren Buffett comb the market during a downturn and sometimes embark on buying sprees. Instead of advising investors to exit the market, he advises them "to be greedy when others are fearful."

Lessons learned

If the bear market of 2022 and a look back at history taught investors anything, it is to focus on companies' fundamentals and stick with well-built financial plans. We don't know what 2023 will bring in terms of the stock market, but we do know what it will require: the discipline not to let emotions rule decision making and the courage to stay the course.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly. The economic forecasts set forth in this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful. There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk. All investing involves risk including potential loss of principle. No strategy assures success or protects against loss.