Our faith in these marvelous markets can be tested when bear markets rage like they have in 2022. It’s natural for our loss aversion tendencies (Investor Behavior Biases) to appear, tempting us to alleviate the uncomfortable feeling. To counter that feeling, anchoring to lasting principles like markets that are inspired by ingenuity and tempered by diversification can help us endure. Where do stock market returns really come from, and why does that matter to your investing?
Markets Are Robust and Random
Before we describe where stock market returns come from, consider these two quotes:
“Whether the currency a century from now is based on gold, seashells, shark teeth, or a piece of paper (as today), people will be willing to exchange a couple of minutes of their daily labor for a Coca-Cola or some See’s peanut brittle.” — Berkshire Hathaway Chairman Warren Buffett
“Whenever you think you’ve found the key to the market, some SOB changes the lock.” — E.F. Hutton & Co. Founder G.M. Loeb
So, which is it? Are market returns driven by the inexorable wheels of commerce, as Buffett’s quote suggests? Or do the market’s mysteries remain under lock and key?
The answer is yes—to both. Capital markets and market returns are concurrently robust and random. It’s up to us to accept both, and invest accordingly.
Markets Are Powered by Ingenuity
Viewing the market’s daily frenzy, it’s easy to forget where all that action is coming from to begin with. Close up, markets are a messy mash-up of companies, industries, sectors, and regions, often locked in fierce competition. But take a step back to view the whole. In aggregate, the stock market is also a forum for capitalizing on our collective ingenuity, which has generated amazing advances as well as strong investment returns over time.
This is at least the case for those who have been there to capture the returns when they occur. Examples abound to illustrate how often we may feel as if a source of returns has played itself out, only to find ourselves immersed in a fresh wave of entrepreneurs who have just begun to innovate. As Dimensional Fund Advisors’ Weston Wellington points out: “Sticks and stones led to hammers and spears, the wheel and axle, the steam engine, and eventually semiconductors and jet aircraft.”
Here’s how the late, great Vanguard founder John “Jack” Bogle described it:
“If you own the stock market for a lifetime, you get those returns. Playing games in the stock market, over every day of that time, is playing the stock market. The stock market game is rigged, the business of investing is not rigged.
Market Performance Is Sparked by Random Chance
Even as global enterprise continues to amaze us, it usually does so in a random walk. While you’ll almost always find handfuls of remarkably winning investments at any given time, you’ll also encounter bucketloads of losers. Moreover, the winners and losers can trade places on a dime. As Dimensional’s Wellington observes: “The benefits of innovation are widely dispersed throughout the economy, often in unpredictable ways.”
Old technology resurfaces in different ways. Consider the UPC barcodes born back in 1974. Starting out by preventing entry errors at the cash register, barcodes developed into massive data pools that allow industries to quickly track inventory, shipping and consumer spending habits. The newer Quick Response (QR) codes emerged in the 90’s but Covid took them to the next level. As highlighted in this Forbes article, Eight Tech Innovations That Will Impact The Market For Consumers In 2022, QR codes gained traction when restaurants began utilizing them for menus during COVID. Consumers were compelled, many for the first time, to adapt to this technology that had been around for many years. Cody Candee observes, “Companies are starting to realize that they can use QR codes as an access point into their products or websites,” providing valuable insight for their business. Keep an eye out and you may notice these codes on ads, business cards, cash registers, church bulletins, smart TVs, payment apps, or even in your garage to control the door from your smartphone. What other old tech will materialize in a new form or expanded use in the years to come?
Capitalizing on the Engines of Ingenuity
It might help to think of the market as a mighty vehicle, like a train. When you climb aboard, your goal is to reach your desired destination by accumulating miles, or market returns, without derailing along the way. For that, you need a solid, Buffett-style engine of global commerce. But that engine also needs a supply of combustible fuel.
This illustrates why markets will always be messy and confusing at a close-up view. Only as we zoom out can we track our progress, in the shape of an upward line of market returns over time and across the long haul.
Because we expect the engines of ingenuity to continue chugging along, we have every reason to remain optimistic, and to stay invested as planned. We also understand why diversification remains equally essential to our efforts—because we never know just where the next sparks are going to fly.
By embracing the reality that stock market returns are random and robust, you can boost your ability to remain calm (or at least calmer) during the maelstroms, and improve your chances for reaching your investment goals over time.
Let us know if we can assist with that.