Investing for the Long Term
Year to date, stock price performance has felt extremely painful given that so much damage has been packed into a 5-month period. There’s a lot for investors to worry about these days including the highest level of inflation in 40 years, an aggressive US central bank that’s trying to tame inflation by hiking interest rates, and Russia’s invasion of Ukraine.
Taken together, these factors have created a lot of chaos in the market. The weakness is especially pronounced in the Technology sector but has also been evident in other sectors such as Consumer Discretionary, Healthcare, and Industrials. To illustrate the carnage out there, Ecommerce stocks (as measured by the ProShares Online Retail ETF) were down more than 60% from last year’s peak. Fintech stocks (as measured by the Global X FinTech ETF) fell more than 50% from last year’s peak. Looking at the NASDAQ, more than half of the companies in the index were down more than 50% from their prior peaks.
We have felt the pain in our portfolios with share prices for our companies down significantly thus far in 2022. Our global and international portfolios declined by more than 20% at the height of the recent selloff. While it’s always disappointing to see our portfolios decline in value, it seems less painful when viewed in the context of the huge gains that were made since the COVID lows in March of 2020. After all, several stock market indices in the US and around the world more than doubled in value in less than a 2-year period.
What’s more important than short term gyrations in stock prices is the long-term fundamentals for the businesses we own. On this front, we are very encouraged as we believe that the long-term fundamentals for our companies remain very attractive.
At times like this, I like to remind myself that historically the market rises about two-thirds of the time. But one-third of the time the markets go down, and sometimes the markets go down a lot. In fact, over the last 15 years the S&P 500 has fallen by approximately 20% or more on 5 different occasions. During the Financial Crisis in 2008-09, the S&P 500 experienced a peak to trough decline of more than 50%. In 2011, the S&P 500 had a drawdown of 20% during a period when the rating agencies downgraded the credit rating of the United States. Toward the end of 2018, the S&P 500 fell by approximately 20% and in early 2020 the S&P 500 fell by more than 30%. And here we go again with the latest market sell-off reaching a 20% decline albeit on an intra-day basis. Living through these periods of market turbulence is one of the most difficult parts of investing. But, if one wants to reap the rewards of long-term investing, there is no practical way to avoid these occasional stock market dislocations. The best way to compound wealth over the long-term is to invest in winning businesses and own them for the long run. Staying the course has been critical to realizing the powerful compound returns of the best companies. And investors must do this knowing that from time to time, they will experience large drawdowns.
In July 2020, Hendrick Bessembinder, a finance professor at Arizona State University, published a series of papers with an important and surprising conclusion. Even the stocks of companies that have created the most wealth for shareholders experience deep and protracted share price reversals along the way. Apple, Amazon, and Berkshire Hathaway are good examples of remarkable companies with exceptional long-term stock performance that have gone through huge drawdowns.
Of all the companies in the study, Apple created the most wealth in the decade from 2010-2019 adding $1.5 trillion of shareholder value. However, there were large retracements along the way. For example, Apple’s share price fell by 40% over 9 months in 2012. Looking back further, Apple shareholders have earned a compound annual average return of 20% since Apple’s IPO in 1980, but they have experienced drawdowns of more than 70% on three separate occasions.
Amazon is another success story and was the fourth-best performer in the Bessembinder study, with shareholder wealth growing by more than $600 billion between 2010 and 2019. But like Apple, Amazon’s stock has not been immune to large drawdowns. Although Amazon shareholders made compound annual average gains of 36% from the 1997 IPO, they also suffered through the dot-com crash of the early 2000’s when Amazon’s share price fell by a whopping 91%.
Large drawdowns also happen outside of the Technology sector. Warren Buffett’s company, Berkshire Hathaway, provides yet another example of this drawdown phenomenon. Even The Oracle of Omaha has also been unable to escape significant drawdowns. From 1980 to 2016 Berkshire Hathaway’s stock price appreciated at an average annual rate of 20%, far outpacing the 10% achieved by the S&P 500 index. Despite the massive outperformance, Berkshire’s stock pulled back by at least 30% on 4 separate occasions during that 36-year period. In one instance, Berkshire’s losses were shocking relative to what the stock market was doing. During the dot-com boom in the late 1990’s, Berkshire’s stock price fell by 44% at the same time as the stock market advanced by 23%, representing 67% underperformance. This led to a plethora of articles that suggested Warren Buffet had completely lost his way. As we all know, this was simply not true.
Market selloffs and drawdowns are difficult. But if investors take a longer term view, as we do at Cumberland, market drawdowns should be viewed as the price you pay in order to receive the wealth-building, compounded returns from exceptional companies. We own a collection of outstanding businesses in our portfolios, and we believe that the long-term fundamentals for these companies remain highly attractive.