Too Much of a Good Thing Can Be Bad
The human body is an amazing self-regulating organism, it can dynamically regulate body temperature, blood pressure, blood sugar, and much more. This dynamic equilibrium called homeostasis is what keeps us alive.
Just like the human body, stock and bond markets are constantly in a process of price discovery to determine the fundamental value of the underlying companies. Because short term price movements are noisy and volatile, there can be large variations around this fundamental value.
Prices rise higher during times of optimism and fall during times of despair. Many times, it has reached extremes in both directions — think bubbles and the corresponding crashes. However, at the end of the day, prices tend to return to the trend of its long-term fundamental value.
A classic case is the Japanese stock market, it went through a mind-boggling period of excess during the 1970-1990 period where the stock market returned a gargantuan +21.92% per year while the S&P500 returned +11.12% per year over the same period.
However, over the ensuing period of 1990 to 2022, the Japanese stock market was essentially flat whilst the American stock market chugged along nicely returning +9.75% p.a.
Most people think that the Japanese stock market never grew for 3 decades, but what actually happened was that all the returns from the future were pulled forward during the two decade excess of the 1970s to 1990s. If we zoom out and look at the period of 1970 to 2022, the S&P500 returned 10.43% p.a. while the MSCI Japan Index returned 8.23% p.a.
As we will undoubtedly go through future periods of excessive optimism which will drive prices and returns higher than it should, we will also go through periods of pessimism, driving down prices and returns. Long-term data shows us that global stocks return an average of 8% p.a. and we can be opportunistic in capitalising when the chance presents itself. Now you just have to steel yourself when markets are bad, and stop yourself from overextending when exuberance is abound.
In the same way that you would not attempt a high risk activity such as sky-diving without professional supervision, investors can benefit greatly by relying on an adviser — having the peace of mind knowing that their plan is in the hands of a professional.
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