Saturday, March 7, 2009

Stocks for the (Very) Long Run

From John Authers's column in today's Financial Times ("Long View: Why baby boomers will put their faith in bonds"):

US stocks have now underperformed Treasury bonds since 1969. Very few savers actively putting money away today started much before 1969. Most of them did so during a period when the cult of the equity held sway. For this whole generation, that belief in equities has proved badly misplaced. Various long-term surveys show that there have been very long periods of underperformance by equities in the past.

But we can say that the current sell-off is almost without precedent for its speed. [Research Affiliates' Rob] Arnott’s figures show that as Wall Street opened on Friday it was already dealing with the second biggest six-month decline in its history. The only bigger six-month drop was barely larger, at 51 per cent, at the end of the crash of 1932.

The good news is that 1932 marked the bottom of the great bear market of the 1930s, and that stocks rallied more than 100 per cent in a matter of weeks.

The bad news is that there were still 22 years to go before stocks regained their highs in nominal terms, and 26 years before they regained their highs in real terms, an event that did not happen until 1958.


All of this could shatter our confidence in stocks as the vehicle for the long run. While the evidence is still unequivocal that they do perform best over the very long term, the periods may be so long that they do not help some people during their lifetimes.

A couple of thoughts on this:

1) The shattering of confidence Authers mentions above, and the associated revulsion toward stocks, explains the multiple compression that Vitaliy Katsenelson wrote occurs during secular range-bound (or bear) markets (see his graphic above, or this post for elaboration on Katsenelson's thesis).

2) This column wouldn't have been a revelation to Benjamin Graham. Unlike the advocates of buy & hold indexing in recent years, Graham was well aware that stocks, broadly speaking, could under-perform for painfully long periods. Graham wrote this on p.12 of the third edition of his Security Analysis, which was published in 1951:

"Prior to 1929, one could say with some logic that the course of common stock prices appeared to be so determinedly upward that the intending holder of high-grade stocks for investment could afford to buy them at any time and to ignore their fluctuations. In the past 20 years there is no longer any clear-cut evidence of an underlying and persistent upward trend in common stocks taken as a whole."

Hence, Graham focused on investment strategies that didn't rely on a secular bull market lifting most stocks1. Incidentally, he didn't know it when he wrote the quote above, but a new secular bull market had already begun when the third edition of Security Analysis was published -- one that would continue for about another 15 years.

The graphic above is from Katsenelson's website.

1Worth remembering though that even Graham took a beating during the Great Crash: According to James Grant, in his introduction to the latest edition of Security Analysis, Graham lost 70% of his money (The Dow dropped 89.5% over the same 1929-1932 period).


Crames Jamer said...

How long it may take to get back to the old highs is irrelevant.

The only question that needs to be answered now is what assets will give you the best total return from today onward.

A 50% move up from Friday's close would still leave the averages about 25% under their old highs but would be a very nice (+50%) return from today's level.

Switching to bonds or t-bills now would be like using birth control after you've found out you're already pregnant.

DaveinHackensack said...

"The only question that needs to be answered now is what assets will give you the best total return from today onward."

That's a good point, Paul.

Worth quoting more from Auther's column here:

"Playing the market at this point is more about predicting the actions of other investors than about placing a value on companies. How will investors react to this fall?

Confidence in stocks is likely to have been shaken, as the realisation takes hold that bonds have beaten stocks over four decades.

Add to this the weight of demographics. Those who started saving in 1969 were in the early years of the baby boom generation. They have only a few years left to retirement, and suddenly have far less wealth set aside for it than they had thought. That will mean saving more, and it is likely that a big chunk of that money will go to bonds rather than stocks.

Once they retire, they will have to sell many of their securities. The generation that has been let down by the cult of the equity may have little choice but to ensure, by their actions, that equities take a long time to recover."

Mark 'The Shark' Hulbert said...

It was noted somewhere today that if stocks merely go back to where they were on December 31st we'd see > 30% returns from last week's close.

That type of move is highly likely before year-end 2009 whether or not we're actually ready for the long term turn.