At least several times a week, I get a note from a newsletter subscriber or other investor who has heard a stock market correction or bear market is coming soon. The next statement is that the investor either plans to sell his stocks until prices drop or wait for the prices to drop before buying into any stocks. Like many commonly held beliefs about investing in stocks, this is one that is likely to cost the investor a lot of money.
Here are a couple of reasons why selling to avoid a market correction or waiting for one to buy will cost an investor money.
Reason 1: No matter what you see or read in the financial news, the next bear market does not appear to be imminent. The main reason to forecast an approaching bear market is because it has been almost nine years since the end of the last one. This logic doesn’t work because bear markets do not follow a calendar. Ten of the last 12 bears have been associated with an economic recession. The current economy gives zero indication that the next recession is on the horizon. History tells us that the economy will at some point go to negative growth, but currently there are none of the usual indicators for a pending economic downturn.
A stock market bear market is arbitrarily defined as a 20% decline from the most recent high. While the last decline of this magnitude occurred in 2008-2009, there have been several “near bear” corrections since then. Here are the three significant corrections that occurred during the current bull market:
- 2010: 16% decline
- 2011-2012: 19.4% decline
- 2015-2016: 14.3% decline
These corrections have acted as circuit breakers that keep the current market values from a place where a big drop is likely just to take off some of the froth. While it is likely that a correction will occur within the next year (they happen on average once a year), a true bear market is very unlikely.
Reason 2: History shows that getting out of the market too early costs you more than riding out corrections and bear markets. Here are some averages on the 12 bear markets since 1937.
- The average decline was 35.5%.
- Average duration from market peak to bottom of 13.8 months.
- Typical decline of about 20% in the first year.
The interesting additional data is that the two years leading up to the bear markets are, on average, the years with the biggest bull market gains. In the two years before the start of the bear markets, the S&P 500 climbed by an average 58% plus dividends. In the final year before the peaks, the average gain was 25% plus dividends. Comparing the numbers, even if you hold on through the average bear market, owning the stock averages for the two years prior to the start of the bear market leaves you with a larger portfolio value than if you had stayed out of the market and had perfect timing to get back in when the bear hit bottom. The not obvious lesson is that getting out too early can cost you more wealth than staying in through part or even all the bear market.
One feature of my dividend focused strategies is that they rule out the need to try to time when the next bear market or correction will start. I can more accurately predict dividend payments than I can swings in the stock market. My strategies focus on finding dividend stocks with a high degree of confidence in the ongoing dividend payments and buy those stocks to build a growing income stream. If the market declines into a correction or bear market, dividend earnings can be used to buy shares at lower prices boosting both the dividend stream and the capital gains when the market starts the recovery or next bull market. A dividend focused investment strategy allows you to take advantage of the proven techniques of dollar cost averaging and to buy low when fearful investors have panicked.
I recommend that income investors focus on building a portfolio of dividend stocks that balances high yield stocks with those where dividend growth is very predictable. Here are a pair of income stocks that illustrate this combination.
Hercules Capital Inc (NYSE: HTGC) is a business development company (BDC) that makes loans in in the venture capital space. Hercules client companies are growth businesses backed by venture capital investors that need additional capital to fulfil their growth and investment goals.
Loans from Hercules provide debt capital that does not dilute the equity holdings of investors and insiders. Hercules typically receives some sort of equity stake or warrant, so generates additional profits when a client company gets bought out or enters the public markets with an IPO.
This BDC has paid a steady, well covered by cash flow dividend for over five years. The shares currently yield 9.5%.
EPR Properties (NYSE: EPR) is a very well-run net lease REIT that has done a great job of growing the business and generating above average dividend growth for investors. With the net-lease (NNN) model, the tenants that lease the properties owned by EPR are responsible for all the operating costs like taxes, utilities and maintenance. EPR’s job is to collect the rent checks. Typically, NNN leases are long term, for 10 years or more, with built-in rent escalations.
EPR Properties separates itself from the rest of the triple net REIT pack by the highly focused types of properties the company owns. The EPR assets can be divided into the three categories of entertainment, comprised of movie megaplex theaters; recreation, including golf and ski facilities; and education which counts in its portfolio of properties private and charter schools, and early childhood centers.
EPR has generated superior returns for investors by growing its dividend an average of 7% per year for eight straight years. The shares yield 6.8%.
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