Business·Analysis

The market's fresh reminder? Stocks don't just go up

The investment product warning label "past performance is no guarantee of future results" can apply to entire markets — and that may be a salutary reminder for pandemic-era investors.

Latest crash in bitcoin and decline in stock prices are useful lessons for new investors

Many news stories blamed the delta variant for a decline on Wall Street and Bay Street. But whatever the real cause, a sharp fall in stocks offered a warning. (Shannon Stapleton/Reuters)

As stocks struggled to claw back their losses following Monday's sharp decline, it was probably hard for investors to see anything good in this week's market rout.

New York's Dow Jones Industrial Average, an index made up of 30 top blue-chip companies, took its biggest plunge since last October, and the Toronto Stock Exchange fell the most it has in nearly five months.

For an increasing number of pandemic-era traders who may have been fooled into thinking they could not lose in what seemed like ever-rising markets, suddenly the traditional disclaimer on investment products that "past performance is no guarantee of future results" showed it can also apply to an entire market.

And while stocks in New York and Toronto climbed on Tuesday, for many, the bad news was not over.

'Stocks only go up'

Even as traders moved to buy the stock market dip, cryptocurrency speculators got a fresh market warning as bitcoin declined sharply again, at one point trading below $29,500 US.

Bitcoin traders who bought the digital tokens at their April high — above $62,000 US — and sold them Tuesday morning would have lost about 53 per cent in three months.

Stories in the financial press suggested new moves by U.S. Treasury Secretary Janet Yellen to increase crypto regulation were one of the immediate triggers — part of a wider trend by governments and central banks to rein in the explosive growth of the tokens.

And while speculators who dipped their toes into cryptocurrency markets may have already learned the "past performance" lesson after their first big decline a month ago, until Monday, investors who spent a few spare hours this spring learning how to invest in traditional securities markets may not yet have got the word.

"It's become popular during the last year to argue that 'stocks only go up,'" U.S. financial adviser Cullen Roche wrote earlier this year on the website Seeking Alpha. "While the stock market is a wonderful long-term asset, it is often a horrible short-term asset."

Reliable in the long term

As Roche and many others have explained, over a 10- or 20-year time horizon, buying shares in publicly traded companies — in the past at least — has been a reliable way of saving for the longer term future, even if stocks can face sharp declines in the short term.

For many introduced to the stock market in the past few months when retail investing really took off, picking stocks was relatively easy. 

With time on their hands and maybe a little extra cash in their pockets, a surge of new investors decided to try their hand at baking sourdough bread and trading stocks.

As with bread-making, most trading is usually done by professionals. But earlier this year, the TMX Group, which owns and operates the TSX, reported that nearly half of all stock trading was being done by retail traders.

"The positive strength in trading, equity trading particularly, and what's driving it in terms of retail interest, is something that we could see for some time," TMX CEO John McKenzie told Reuters at the time.

But how long that retail interest will last if stocks reverse their recent upward trend remains to be seen.

Because while rock-bottom interest rates and government handouts since the pandemic hit may have helped make investing feel safe, analysts remain wary about what will happen once central banks decide it is time to increase interest rates.

According to the random walk theory of markets, described as the theory "that stocks take a random and unpredictable path that makes all methods of predicting stock prices futile in the long run," successfully picking stock is as much art as it is science.

Finding nuance

The market's long, recent upward trend — first during the Trump tax cuts, then during pandemic stimulus — is not normal. 

You don't have to go back to the Great Crash of 1929 to see that markets can also decline or tread water, as the graph above shows.

Just as some headlines about the bitcoin crash blamed Yellen, most of those reporting the stock market decline focused on a single cause: namely the renewed outbreak of COVID-19 driven by the delta variant.

But as we have seen in the past, in the copy below the headlines, the explanation was more nuanced.

In Canada, where the spread of the delta variant has so far been discouraged by increasing vaccination rates, the market decline was more directly attributed to what many believed was over-optimism about the price of oil, which fell about seven per cent Monday following OPEC's move to pump and sell more into world markets.

Despite the recent surge in the need for oil after the pandemic slump, fear of the effects of climate change and a push for more electric cars will presumably reduce demand eventually.

But as random walk reminds us, there is plenty we don't know about the future of energy company stocks.

Maybe, as with baking sourdough, the fad for investing will pass. But for those learning their way, personal experience, including when stocks fall, can provide a valuable education that can last a lifetime.


Follow Don Pittis on Twitter: @don_pittis

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