Broker Check
"Lessons Learned From The Rubber Band...."

"Lessons Learned From The Rubber Band...."

April 01, 2020
Share |

As I sit to write out my thoughts during this most calamitous of equity markets, I can’t help but think of that common office staple:  The Rubber Band. 

The rubber band is complex in its chemical makeup.  Technically speaking rubber is a polymer of isoprene (also known as 2-methylbuta-1-3 diene) with the chemical formula (C5H8)n.  Rubber can be derived from plants, and can also be reproduced artificially in a chemical plant or laboratory.  The plant version of rubber is also called latex.  Latex can be found in many common plants.  How many times have we snapped off a stem of a dandelion when we were kids, and noticed the milky white liquid oozing from it?  Yup, that’s latex, and rubber bands can be made from the common dandelion (although granted you need a WHOLE lot of them).  There are over 200 plants worldwide that produce latex. 

Why on earth Lon, are you talking about rubber bands, and their chemical makeup in the middle of a market panic? 

Very simple - rubber bands can teach us a lot about our own investment strategies.

I’m sorry what was that?

Stay with me here for just a moment.  The characteristics of a rubber band are eerily similar to the equity markets.  Pull back a rubber band just a smidge and then let it go, how far is it likely to go on the rebound?  Not far at all.  S-T-R-E-T-C-H a rubber band back as far as you can, and upon its release you’re likely to see it fly across any room. One quickly discovers, with a childlike curiosity, that the rubber bands’ rebound is directly proportionate to the pullback.

In other words, the rubber band is the perfect metaphor for the equity markets.  When the equity markets do finally rebound to the upside, that upside has traditionally been in direct proportion to its drop. 

Let’s look at the following chart, which you have seen many times:

 

What you’re looking at is the average intra-year declines in the S&P 500 going all the way back to 1980.  Closer inspection of this chart finds that the average intra-year decline of the S&P 500 Index is -13.4%.  As you can see some years the intra-year declines are higher than the average and some other years, they are lower than the average.  The larger point being that there is no discernable pattern in downside volatility. 

What IS a discernable pattern is the permanent upside movement of the S&P 500 during the time frame of this chart.  On January 1st, 1980, the S&P 500 Index stood at 105.70 and as of this writing the S&P is currently at 2,510.79.  Meaning that the S&P 500’s price has increased over 2,000 times since the beginning of this chart.  Just as impressive is the increasing income being produced from these great companies.  In 1980 the dividend from the S&P 500 companies stood at $6.44 and last year it was $58.80, or over 800% higher!  In other words, just through dividends alone, your purchasing power was kept intact throughout the course of the last 40 years. 

While history may not repeat itself, it does rhyme.  Equity market declines have always been temporary, while equity market advances have always been permanent.

In times of crisis, panic is rarely a helpful emotion.  It’s natural to feel anxious and scared during a pandemic, however, discipline and rational choices are especially important, but particularly hardest to implement. 

If thinking of anything today regarding your investments, please remember that this too shall pass.