I reread an interesting article written in August 2015 by Joshua M. Brown, which is really fascinating and applies perfectly to this past year, 2018.
His logic is that the market must experience a descent at times because without a risk of decline, there will never be gains.
Let’s try to imagine a world without stock market slumps. What price would you be willing to pay for a publicly traded company’s share knowing that it could never lose value? For what other reason except for the sake of liquidity would you sell this share?
In theory, an investor would be willing to pay an exorbitant sum for such an investment and hold on to it indefinitely. Eventually, the investor would certainly come into his or her money. Wouldn’t this be the ideal environment? According to the author, such a scenario would be a horror story and I quite agree with him. Stock market indices would deal in astronomical prices without any backing. They would remain high for very long periods of time without clear increases.
An equilibrium would eventually be reached, but in this reality, the market would have weakened because if there’s no risk, there’s no gain either. And investors would say: “I’m going to do other things with my money!”
The only reason shares gain value is because they can lose it. It’s this risk that keeps investors on the lookout to avoid paying outrageous prices for a company’s shares.
The return of volatility this year is undoubtedly a good thing because historically, when popular belief is that stock markets can’t fall, serious corrections result from this. And the technology bubble has certainly been one of them.
Fear is the most fundamental factor in the investment process. It must constantly be on investors’ minds to profit from any eventual increase.
The stock market investor is rewarded for braving this fear because many don’t dare to face it.
1 Investment advisor at Ritholtz Wealth Management LLC.