Recent events are, once again, demonstrating the volatility inherent in equity investing. Few investors seem to mind, or even notice when volatility is on the upside, but when it comes to downside volatility that’s a horse (or bear) of a different color.
The latest cause de jour is the trade negotiation spat between the U.S. and China which has taken on a pessimistic hue. The U.S. is claiming China has reneged on key provisions previously agreed to in the draft version of their trade deal. China says it would have to change its laws to comply, is unwilling to do so and may now try to wait out the next U.S. Presidential election, hoping for an easier trade negotiator in the White House. We shall see how this plays out, but investors should not mistake this temporary glitch in the permanent uptrend of equity values as anything more than what it is – a temporary glitch.
One way to view these short-term price swings is the cost of admission to this wonderful wealth creation opportunity to which almost anyone who can scrape together two nickels has access. For without the volatility inherent in common stocks there would be no premium return over less-volatile assets. It is the very uncertainty of future returns that creates the opportunity. Think about it. If stocks had zero volatility, they would produce zero additional return over other assets such as cash or T-bills that have little to no price volatility. No uncertainty equals no excess return opportunity.
There are two components that create the increase in equity values over time: (1) growth in corporate earnings and (2) dividends (also growing) that companies pay out as a percentage of those earnings. Historically, U.S. companies have grown their earnings at a 7%-8% annual rate and many pay a portion of their earnings to shareholders in the form of quarterly dividends, typically yielding 2%-3% annually. As companies’ earnings grow, so grow their dividends. That combination of earnings and dividend growth is what has produced the approximate 10% historical return from U.S. equities, some years more, some less, some none.
It is not the daily, weekly, monthly or even yearly changes in stock prices that matter, but instead it is the never-ending long-term growth in populations, incomes, consumption, GDP, and the revenue, earnings and dividends of publicly traded corporations. Intelligent, creative and opportunistic people will constantly seek ways to offer consumers best-fit products and services to meet their ever-evolving needs and wants. And consumers, by the billions will get up daily making sober and intuitively rational price-value comparisons on how and where to spend their hard-earned dollar, pound, Euro, yen, won, yuan, rupee or dozens of other currencies. The companies that produce and supply the goods and services the world’s consumers want to buy are the ones that will continue to create wealth for those shareholders willing to pay the price of admission.
In the long run we may find that the price (short-term volatility) was modest indeed compared with the wealth created over a lifetime of prudent saving and investing.