Key to making money in stocks is not to get scared out of them

The following is an excerpt from Kirr, Marbach & Co.’s second-quarter client letter, available at www.kirrmar.com<http://www.kirrmar.com/>.

As the media has reported ad nauseam, the first half of 2022 was the worst start to a year for the U.S. stock market in over 50 years. Additionally, it was the worst start for the bond market ever. We are currently in a bear market (usually defined as declines greater than 20%). This is not something to be feared, just understood. We’d like to share four important points to maintain good perspective:

1. The history of the market is still being written. “Worst ever” and “best ever” will continue to occur and dominate the headlines. The media will have a heyday with it. We simply accept it as a fact of life and choose to stay out of the mess.

2. While bear markets are very uncomfortable and can instill fear, they are an essential element of healthy capital markets. They squeeze out the excess, encourage companies to become more efficient and pave the way for the next bull market.

3. The greatest asset an investor has is personal choice. We cannot control (nor predict) markets or macroeconomic things like inflation or recession, but we CAN control how we respond. Some will seek “safety” and choose to sell in the face of losses. We think it is far better to exercise patience and “strategic ignorance” — choosing to ignore and cultivate an attitude of indifference to financial news and account values until these things get worked out.

4. Investor angst is at an all-time high. The combination of sky-high inflation, the Federal Reserve (Fed) aggressively tightening credit and a potentially looming recession has crushed investor confidence, which is at a 10-year low. Don’t get shook. If history is any guide, and there is no guarantee it is, it’s not uncommon for stocks to have sharp rebounds following horrible half-years like the one we just experienced.

* According to Bespoke Investment Group, the first half of 2022 was just the eighth time since WWII when the SPX dropped 20%+ in a two-quarter span. The SPX was up the following quarter in six out of the prior seven occurrences (average gain 8.5%), and the following half- (21.5%) and full-year (31.3%) all seven times.

Inflation and recession

1. We are in a period of high inflation. While it may not keep going higher, these elevated levels will likely persist for a while. With the Federal Reserve (Fed) attempting to fight inflationary pressures by reversing its pandemic-induced emergency measures by increasing short-term interest rates and halting its program of “quantitative easing (QE-which kept a lid on longer-term interest rates),” we will not be surprised if many global economies (including ours) go into a recession (or are already in one).

2. The National Bureau of Economic Research (NBER), the quasi-official entity that declares when recessions start and stop in the U.S., uses a somewhat “squishy,” non-precise definition of recession as a “significant decline in economic activity that is spread across the economy and that lasts more than a few months.” A recession is often the cure for the disease of inflation. Investors have a visceral reaction to the “R-word,” so expect the media to try to continue trying to instill fear about an upcoming recession. We acknowledge the facts but need to stay clear from the fear mongering.

* Recessions are a normal part of the economic cycle.

* Every recession has been followed by an economic expansion. Every economic expansion has been preceded by a recession.

Looking forward

1. Anticipating what we may experience and how we may feel can help investors make better decisions. We should expect the media will promote every piece of negative news they can (fear sells). We should expect to get concerned and perhaps feel some fear about the future. It’s perfectly normal. In fact, the more we tune in to the media and look at account values, the more fear we can expect to feel. And the more fear we feel, the more we may be tempted to make a very unwise decision.

2. We can also learn from history. Remember back to March of 2009. It was ultimate despair after going through over two years of a Global Financial Crisis with little hope things would improve. There was nothing positive to look forward to. And yet, that was when the market hit bottom. Since March 9, 2009, the SPX compounded at a whopping 16.1% annually (at that rate you double your money every 4.5 years) through June 30, 2022 (even with the current swoon). Those investors who stayed in the market reaped the benefit.

3. During these times, the best thing to do is focus on what you control. You control your spending. You control what you pay attention to. You control your investment allocation, which was constructed with the expectation that recessions and bear markets will occur. While it can be uncomfortable to live through, none of this is unexpected nor outside the realm of what happens in healthy capital markets.