After a turbulent trading session, equities rallied into the close as February ended, with the widely followed Dow Jones Industrial Average soaring 601 points, or 1.39%, on the final day of the month.
Of course, one might have expected the day to have ended deeply in the red, given Breaking News like, “Talks between President Donald Trump and his Ukrainian counterpart Volodymyr Zelenskyy regarding rare earth minerals collapsed.”
And this headline might not have inspired enthusiasm toward equities: “The U.S. economy is setting up to take a major step back in the first quarter after a pair of reports showed weaker consumer spending and a dramatic widening of the trade deficit at the start of the year, according to the Federal Reserve Bank of Atlanta’s latest GDPNow forecast.”
No doubt, it is hard to figure out why stocks do what they do in the short run, and investing has always been an emotional ride. I’ll be the first to admit that it’s easy to get caught up in the daily swings of the market. But as our founder, Al Frank, taught me early on in my investing journey, and after decades in the market, I’ve seen time and again how investors who keep their cool, especially when fear is running rampant, tend to reap the biggest rewards.
Main Street Is Uber Bearish
I could argue that the big bounce to close out February was because investor sentiment was about as gloomy as I’ve ever seen it. Believe it or not, despite the major market averages still within shouting distance of all-time highs, the latest weekly Sentiment Survey from the American Association of Individual Investors (AAII) showed only 19.4% of folks on Main Street were bullish. This is well below the historical average of 37.5%, while a staggering 60.6% were bearish, compared to a norm of 31.0%.
Those figures put the bull-bear spread at negative 41.2%, one of the most pessimistic readings on record. History tells us that when sentiment reaches these levels, it’s usually a sign that much better days are ahead.
History Doesn’t Repeat But It Often Rhymes
To be sure, this time (and every time) is different, while past performance is never a guarantee of future returns, but we don’t have to look far to see what happens when the AAII folks freak out. In March 2009, as the financial crisis raged on, the Bull-Bear spread hit negative 51.4%, right at the market bottom. Many thought stocks were finished, but six months later, the Russell 3000 Index was up 52.7%!
In October 1990, when the first Gulf War was providing scary visuals on the evening news, 70.3% of AAII survey participants were bearish. Six months later, the market had surged 40.3%. True, today’s number of Bears is not as great, but across the six other instances where the number of Bears exceeded the current level over the 37+ year AAII history, the average six-month return has been 19.3%, compared to the “normal” return over that time span of 5.9%.
Time after time, extreme pessimism has set the stage for outsized gains, on average, as evidenced by the 39 previous times where the number of Bulls has been equal to or less than the present tally. True, not every subsequent short-term period was green, but we can’t complain about an average six-month return of 12.2%.
A Word From My Mentor
Al Frank knew to keep his head when those around him were not. Back in 1979, in the midst of market chaos, he wrote: “I sometimes lose perspective and feel that I am in a battle with almost life and death outcomes. Will the Bull gore the Bear, or will the Bear maul the Bull? Perhaps we should see the market more as populated by chickens, what with all the clucking and squawking at every ruffled feather.” The truth is, most investors react to short-term headlines rather than long-term fundamentals, and in doing so they often miss out on the very best buying opportunities.
Yes, the world is uncertain today, but uncertainty never really goes away, even as it’s natural to feel uneasy when markets are rocky. But I know that fear is often the market’s greatest gift. Al had another saying that I keep in mind during disconcerting times: “They are having a sale in Wall Street, with recently increased discounts. Now is a good time to buy selected common stocks for long-term capital gains in a widely diversified portfolio.”
We will have volatility ahead, but I see no reason to alter my enthusiasm for the long-term prospects of undervalued stocks. Warren Buffett states, “We should be greedy when others are fearful,” and I might argue we should be very greedy when others are very fearful!
For those who like what I have to say in this forum, I suggest taking a look at The Prudent Speculator’s latest Special Report.
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Disclosure: Please note that shares of the stocks mentioned are owned by asset management clients of Kovitz Investment Group Partners, LLC, a SEC registered investment adviser. For a list of stock recommendations like these made in The Prudent Speculator, visit theprudentspeculator.com.
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