Strategy Lab

Why you should celebrate falling markets

The Globe and Mail

one pound coins (adrian brockwell/Getty Images/iStockphoto)

Andrew Hallam is the index investor for Globe Investor’s Strategy Lab. Follow his contributions here and view his model portfolio here.

The only time I remotely resemble a fist-pumping Roger Federer is when stock markets fall dramatically. The first three weeks of November didn’t deliver a grand market slam, but I relished the market’s stumble.

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Each of the ETFs in my model portfolio grew cheaper. Of the 28 stocks recommended by my fellow Strategy Lab colleagues, 25 fell in price.

It was a fabulous three weeks.

That’s right: Unless you’re retired, or close to it, falling markets should be celebrated. After all, plunging stock prices give investors a chance to buy more shares at a discount.

The notion that bad markets are good opportunities is a tough thing for inexperienced investors to get their heads around. They are often happy when markets rise. But as Warren Buffett likes to point out, this makes as much sense as celebrating the rising costs of groceries.

My fellow Strategy Lab columnists are smart investors; I’m fairly certain they prefer falling markets, as well. But they may not smile as broadly as a typical index fund investor.

When you’re buying an individual company there’s always the risk that the firms you’ve put your money into won’t survive a market purge.

Index investors don’t face the same risk because any broad stock market index includes scores if not hundreds of individual stocks. If a handful of companies fail, so be it. The index marches on.

During 72 per cent of the years between 1928 and 2011, the U.S. stock market has gone up. Results from the Canadian market are similar. When stocks fall, it allows index investors to buy more, readying us for the profits delivered by the next, inevitable market surge.

But what if that surge doesn’t come? It’s a fair question to ask. There have been times – like the Great Depression, the 1970s, or the past decade – when individual markets have stagnated for years.

However, if you are buying a global stock market index or simply hold a diversified blend of low-cost index funds that span many international markets, you should feel very comfortable when the markets drop. Globally, markets recover. They always have. No 20-year period in history has experienced a global market loss.

When globally diversified indexed portfolios fall, investors can confidently buy more, or rebalance their portfolios to take advantage of cheaper prices. It’s not so easy for an individual stock picker.

Consider General Electric Co., one of the great blue chip U.S. stocks. For decades, it increased earnings and ratcheted up dividends. But its stock price is still nearly 50 per cent below its peak from a dozen years ago.

Should you average down on a falling stock? Sometimes you should, but sometimes you shouldn’t. And nobody can tell you for sure. Many once great stocks have fallen from favour, some going to zero. Unlike a basket of global indexes, your money won’t always rebound.

In the Strategy Lab portfolios, each of my colleagues has a decision to make about stocks that have fallen in the past three weeks. Should they add money, leave the stocks alone, or sell? Chris Umiastowski’s Apple Inc. has fallen 17.5 per cent. John Heinzl’s McDonald’s Corp. is off 6.5 per cent, and Norm Rothery’s Dell Inc. has stumbled nearly 15 per cent.

An index investor doesn’t have such worries because global markets have always lurched forward. Even Japan’s market bubble couldn’t bust like an Enron or a Worldcom. Unlike these extinct businesses, Japan continues to run.

Index investors can be greedy when others are fearful and fearful when others are greedy. Best of all, they never have to second-guess their decisions. No stock picker in history has ever had that luxury.

See Andrew Hallam's model portfolio here.