Monday, March 16, 2009

Rally Time

I've received several comments in the past few days from people wondering if the market's rally since March 10 is a sign that the bottom is in place.  My answer:  I have no idea.

Too many investors are bipolar paranoid schizophrenics.  They overreact to short-term moves.  They get depressed when the market declines, and elated during rallies.  These are the people who help to create tops and bottoms, because they buy when stocks are going up and sell when they're going down.  

My core belief is that high-quality stocks purchased at current prices will double or triple in the next three or four years.  That's a reasonably bold prediction in itself.  I think it's got a reasonably good chance of success.  Let's think about what that means-- if a stock doubles in four years, it will have generated an annualized return of about 19% over that period (excluding dividends).  If it triples in three years, that's about 44% per year.  Of course, not every one in my portfolio will triple.  However, I believe that at current levels, the risk reward tradeoff is firmly in my favor.  How much lower can the market go?  The S&P 500 isn't going to zero.   It isn't going to 200.  I'm not nearly as smart as some famous bearish prognosticators, but even they seem to be looking at a worst case bottom around, let's say, 500.  If the market is there in three years, that means it would have returned a compound annual rate of negative 12.6%/year over three years.  To me that's a very favorable risk/return bet-- up 19% to 44% versus down 12.6%.  These numbers seem overly precise, and they are.  I'm merely trying to put some theoretical bands on my expectations.  

But the point is, don't agonize over every tick.  If you get depressed when the S&P trades down 20%, maybe you shouldn't be in the market.  There's no law that says you have to invest in stocks.  Conversely, don't high-five your spouse or your drinking buddies after a five day rally.  Both of these things will happen, but they're mostly short-term noise around a bigger trend.  

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