Rip van Winkle woke up to a completely different world

One of the insightful bits of investment wisdom is that you don’t have to recoup a loss by stubbornly holding onto the same investment that caused the loss and hoping it will “come back.” In other words, it’s okay to sell a loser and redeploy the money in another opportunity that may have better odds of going up in value. That seems to be what Greece and Italy are doing with their leadership change. These countries just dumped their political leaders and are betting that new leadership will calm the financial markets and drive important structural reform.

Greece is now counting on Lucas Papademos and Italy is counting on Mario Monti to lead their countries out of their debt mess.  If these guys take swift action and gain credibility, it could help the markets. As Barron’s pointed out this past weekend, “In the absence of new and nasty headlines or evidence of acute market stress, the default mode of stocks – at least for now – is to hang firm or to climb a bit.”

As of last Friday, the S&P 500 index turned positive on a year-to-date basis. We’ll have to wait and see if political change in Europe is enough to kick start the tired markets toward a climb out of the doldrums.

Rip van winkle slept for 20 years and awoke to discover that his world had changed dramatically. The U.S. stock market has been “asleep” for about 13 years now and in another seven, we may find our world is much different, too.
In the nearly 13 years between January 11, 1999 and last Friday, the S&P 500 index rose as high as 1,565 and dropped as low as 676. During that volatile period, we witnessed numerous impactful events including the following:
• The bursting of the dot-com bubble
• The rise of the euro
• 9/11
• The war on terrorism
• The rise and fall of the real estate bubble
• The spectacular rise of the price of gold
• The Southeast Asia tsunami and the Japan tsunami
• The rise of social media
• The Great Recession
• The sovereign debt crisis

Yet, with all those world events and the tremendous moves in the S&P 500 – both up and down – during those nearly 13 years, guess how much the S&P 500 price changed between January 11, 1999 and last Friday?
Exactly zero!
That’s right. The S&P 500 closed at 1,263 on January 11, 1999 and at 1,263 last Friday, according to data from Yahoo! Finance.
Does this mean you should never invest in the stock market because it’s been flat for so long? No. Here are five things to understand from this long market malaise:
1. Dividends matter. While there was no price change between these two time periods, reinvesting dividends or owning investments that pay dividends may have generated a positive return.
2. Diversification matters. The S&P 500 was flat, but some other asset classes did fine over the past 13 years, so it’s important to search far and wide for investment opportunities.
3. Perspective matters. It’s easy to get caught up in the large day-to-day swings in the market, but understanding the broader trend or context of the market is important to help prevent day-to-day volatility from causing you to make bad investment decisions.
4. Patience matters. As long-term investors, we’re more like the tortoise than the hare. Short-term, rapid traders create a lot of noise and may lead the pack from time-to-time, but we’re focused on winning at the end, not at each checkpoint.
5. Valuation matters. The bubble-like values placed on some companies in the late 1990s were so out of whack with normalcy that it’s taken the market many years to work off those excesses. So, while patience is important, it’s also necessary to understand that valuation at the time you make your investment could have a major impact on how long it takes to get a return on your investment.

Nobody knows if the market will remain “asleep” for another seven years to match Mr. Van Winkle. Regardless, the world will be different and our challenge is to figure out how to reach our destination without the nightmares.