Your Fitbit or similar monitor will illustrate that night after night, your deep sleep lasts for almost exactly the first four hours. That’s the sleep you really need. Time spent tossing and turning after that is important primarily to “work out the conflicts in your life.” Those who have no conflicts, in theory, only need the first four hours of sleep. When those four hours are up, those who are “conflict-free” reportedly bound out of bed and start, well, tweeting in some cases.
Conflicts and anxiety for many have their roots in financial concerns and specifically, stock market prospects. We know that for savings and investments to grow and to outpace inflation, we need to have at least some percentage invested actively in investments that involve risk. We’re talking about stocks or real estate.
For most people, owning a home is a decision made for lifestyle reasons, and the fact that it proves to be a good investment over time is incidental. Stocks, on the other hand represent a conscious effort to make money primarily for the purpose of enjoying an adequate retirement. For this reason, most of us have more than a casual interest in future stock market performance, so what do we need to know in the way of fundamentals to alleviate our anxiety and feel rested?
Isolating the fundamentals of what drives market prices is step one.
It’s pretty simple since there are only two variables to predict: Earnings of companies (E) and the price-to-earnings ratio (P/E). For analysts, the earnings number is the easier of the two. Most companies have a lot of inertia and changes are incremental from period to period. Economic growth, inflation and interest rates are the major drivers of earnings forecasts — with interest rates having the most impact.
The (P/E) ratio is the public’s valuation of the earnings. This is the public’s collective guess at the price to pay today for a stock that is expected to earn a dollar a share for the foreseeable future with possible increases over time. Some refer to this price as the product of “efficient markets,” which means that the price of a stock is always the correct one because it is determined by what willing buyers are paying willing sellers, assuming all have the same information.
Unfortunately, this doesn’t explain the occasional “bubble” we have to endure, and some astute financial minds such as former Federal Reserve Chairman Alan Greenspan in 1999 testified to Congress that high stock prices were justified because “hundreds of thousands of informed investors can’t be wrong.” Well, the public’s assessment of a stock’s value can be influenced by human emotions such as confidence, fear and greed. In the case of bubble-inducing confidence, a phenomenon like increased productivity during the 1990s left the public convinced that stocks were worth more than they proved to be. In the panic of 2008, the fear factor drove values down even while the majority of companies were increasing profits. In short, the public’s instincts can get ahead of what’s real — and later there’s a reversion to the norm.
Step two of this anxiety-relief program is to develop a sense of market history to understand how market values in the past have responded to changes in the fundamentals. Reducing the “fear of the unknown” is the key to minimizing what can keep us awake at night.
The crashes tend to recover quickly and forcefully. The average market return following each of the eight crashes since 1970 has been an average 37 percent gain in the 12 months following the day the market hit bottom. From 1946 until 2016, the market gained in 50 of those years and declined in just 29 of them. Most of the declines were relatively slight. Tons of anecdotal evidence confirms the wisdom of buy-and-hold investors.
Still need a sleeping pill? Just add some bonds or bond funds. A 50/50 mix reduces the impact of a market crash to about a third of what all stocks might have done. It reduces potential gains, however, by about 25 percent — from 10 percent to about 7.5 percent. It’s a cheap price to pay for a good night’s sleep.