In case you missed the news, on September 20, as the third quarter of 2010 was rolling to a close, the National Bureau of Economic Research announced that the Great Recession ended over a year ago in June 2009. However, this seemingly great news was largely ignored by the general public. Why the indifference?
Actually, it is perfectly understandable when the rest of the story reveals unemployment rates still hovering near 10%, foreclosures overwhelming an already strained housing market and stock markets still well below their pre-recession peaks. The dichotomy of good and bad economic news continues to reign as the theme of the day. So the real question is, "What should you do about it?"
Allow me to digress for a moment, if you will. I was recently playing basketball with my son in our backyard. At one point the ball went under his foot as he was running, and he ended up on his shoulder, sliding across the brick pavers. Needless to say he was suddenly in a lot of pain.
There was actually about a one-second delay as he processed what had just happened. How badly am I hurt? What is going to happen to me? What should I do next? After determining there was no major damage, we went inside the house and put some ice on his shoulder. He proceeded to take pride in showing off his battle scar to my wife and her parents and then took extra care to protect his shoulder for the rest of the day.
The next day he was still pretty sore, but started to feel a little better. By the third day he was recovering and already back out on the basketball court with his friend. As I write this letter, he still has a silver-dollar-size scab on his shoulder that continues to heal as he goes about his daily activities, the initial injury largely forgotten.
Maybe you already see where I am going with this, but as we look back on the last couple of years, I would argue that many investors have been through the emotional equivalent of what my son experienced after falling on his shoulder. A sudden unexpected shock to the economic and financial markets caused an immediate sense of fear. How badly am I hurt now? What is going to happen to me? What should I do next?
As the initial shock faded, the next step was to assess the extent of the damage. Make sure adequate cash reserves were in place, make sure the asset allocation was still appropriate and make sure the financial plan was still on track. Finally recovery took hold in a slow and steady manner. In fact, recovery is still taking place.
Despite the ongoing recovery, pessimism is still at fairly lofty levels when it comes to the economic and financial state of the world. Corporate America continues to "self-insure" by stockpiling cash. Investor dollars continue to exit equity mutual funds despite the phenomenal resurgence that has taken place over the last 18 months or so. Healthcare reform, financial reform and a pivotal election leave our heads practically spinning with uncertainty as to what to expect in the coming months and years. This brings us back to the question, "What should you do about it?"
As much as it pains me, I know my son is bound to get hurt again. He also knows there is a very good chance he will experience another painful injury at some time in the future while playing basketball. But will that prevent him from playing? No.
Likewise, we know that the financial markets will give us more pain at some point in the future. You might ask, "Why don't I just sit out until I'm fully healed?"
But it is important to remember that we cannot predict when the next painful market experience is going to take place any more than my son can predict when he will get hurt again playing basketball. If you try to sit out of the market until it "heals," you will inevitably end up sitting out until it is even higher than when you originally left.
Even worse would be the periodic "fat tail" we get from the markets, where returns skyrocket in a very short period of time. Remember, many years' worth of returns can take place in just a matter of months, and there is no way to make them up if you are on the sidelines when they occur. The bottom line is if you need or want the long-term returns possible with stocks, you simply cannot afford to sit out.