Investing before the market bottoms – How bad is the pain?

At the risk of sounding repetitive, I want to reinforce my point of differentiating between market bottoms and opportunities.

I’m on the Investment Committee for three different foundations, The Marine Corps Heritage Foundation, the Community Foundations for Northern Virginia and The Station Foundation. All three foundations are reviewing their first quarter portfolios, holdings, and performance. One of the common discussions is, “Should we be putting cash to work right now or is there still more downside?”

So, like many, I’m living the emotional rollercoaster of wondering about a market bottom or the market bottom.  On one call I paraphrased a Warren Buffett quote, “I like to eat hamburgers, so when I see them on sale, I buy them and eat them.”

Well, the quote is something to that effect…but you get the point.

Foundations are different than individual investors in one regard – they are essentially indefinite life organizations.  Other than planning out their annual cash needs from the portfolio, they don’t have any future event like retirement to plan for.

They have an infinite time horizon!

Yet even with a time horizon of infinity, these committees still have PEOPLE on Boards and Committees…all subject to their own formative experiences, behavioral biases, emotions and human tendencies.

So, after one call, I decided to do a little history project and combine it with some arithmetic. That should scare any reader I went to high school with, especially if they were one of my teachers.

My good friends at YCharts (@ycharts) helped me by exporting data on the S&P 500 going back to the 1950s (that’s as far back as they had data, but it’s good enough).  Disclosure – I’m a paying customer, I get nothing from them by highlighting their data and product here – I just really like the service and especially the support I get.

I wanted to see what returns looked like assuming an investor dumped money into the S&P 500 index at some point after it started to sell off from an all-time high (ATH), and that sell-off resulted in what is historically considered a Bear Market.

I had to make some assumptions as to “when” that investment would happen and since I’m reading a lot about how Bear Markets “bounce” then sell off again, I just picked the date three months prior to when market bottomed out and started a recovery.

Across the top, you’ll see descriptive boxes.

Follow along the 2008/2009/2010 date range as an example – it’s a row in gray.

The first two columns from left to right show that the S&P 500 index hit an ATH level of 1,576.09. From there, it sold off to a market bottom index level of 676.53 on March 9, 2009. This was a peak-to-trough loss of -57.1%.

The next column shows the S&P 500 index level of 888.67 on December 9, 2008, which is three months prior to the bottom. Its -23.9% return is how much the index was down on that day from the ATH of 1,576.09.

The next few columns show the S&P 500 index levels and returns six, twelve and eighteen months from the December 9, 2008 “imaginary investing date” (which is also three, six and twelve months after the BOTTOM.) In this example, the returns from December 9, 2008 are +6%, +16.3% and +28.3% respectively.

Finally, there is a column that shows what the return would be eighteen months after December 9, 2008, relative to the last ATH.  In this example, eighteen months later, the S&P 500 was still -27.6% BELOW the ATH.

Here’s the point – there’s a good chance that even if an investor invests too early and has a negative return down to the bottom, they will regain the losses and even be positive in relatively short order.

As you can see, in all but two periods, any investment in the S&P 500 three months prior to the ultimate market bottom is green (positive) in 18 months. In some cases, it’s SIGNIFICANTLY positive.  The only exceptions are 1963 when the “early investment” was still negative -0.7% and in 1987 when the “early investment” was still down -14.2%.

The 18-month returns made three full months before an eventual bottom in order from highest to lowest are:

+36.1%, +28.3%, +12.0%, +11.3%, +10.4%, +9.0%, +5.6%, +5.4%, +2.0%, -0.7% and -14.2%.

You may not catch THE market bottom, but in most cases, being early is not going to do a lot of damage to an investor who seizes the opportunity.

In other words, if you like hamburgers and they are currently on sale at 20% off, you should buy some – because right now they are a good deal.

And let’s face it, you were probably okay buying them in November, December and January at full price anyway…when they were 0% off.

Keep looking forward,

Dave

(Also see our disclosures, I have to say that because I’m human and I could have made a mistake. I checked my formulas carefully, but still…)

 

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