On August 13th, 1979, Business Week ran on its cover a story entitled “The Death of Equities.” Between the covers, the magazine opined that the condition — a flattening of stock returns — had to be regarded as a “near-permanent condition.” When the article was published, the Dow was trading at 875 and had been in essentially a see-saw pattern since it had peaked at just over 1,000 in late 1972. The article was published on the heels of a dismal period in the US economy – one that included historically unprecedented oil prices (a 60% rise in 1979 alone) and double-digit inflation. Additionally, the article predicted that large institutional investors (e.g., pension plans) — by far the largest holders of US equity shares — would soon be fleeing the market out of necessity, to seek higher returns, and that this would almost certainly drive the market down further. By most standards, the outlook couldn’t have been worse. In the two years that followed, the Dow rose 17%, followed by yet another dip to 776, before beginning what would become the greatest secular bull market in US history. That rise would continue for nearly 18 years bringing the Dow to 11,500 in late 1999, an unprecedented 16% per year average return (not including dividends and inherent trading costs).
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As I write this, I’m a bit tired from having stayed up too late last night watching the New Hampshire primary returns. What an interesting evening that turned out to be! If you followed the polls in the days leading up the NH primary, then you know that virtually every poll – including Hillary Clintons’ own internal tracking poll – showed that Barack Obama would almost certainly win with between a 1% and 13% lead going into the primary. Even MSNBC’s exit polls predicted a 5% margin of victory for the Obama camp. Despite what appeared to be insurmountable momentum coming out of Iowa, and every poll and every pundit in the county seeming to assure an Obama win, somehow, that turned out to be exactly what didn’t happen. (Stay with me here, there’s a point coming eventually.)
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This has been a difficult six months in the market. The subprime mess which “blossomed” in late July, has spawned a series of earnings write-downs, a tightening of credit, and added significantly to concerns about an economic slowdown, and possibly a recession. The Dow has gone from 12,500 at the beginning of ’07 to 14,100 (in July ’07) and then back to 12,600 as I write this. Despite a dismal second half, 2007 was not a total disaster, with most clients performing positively, though unimpressively, overall for the year, thanks in large part to broad diversification.
So, what’s ahead? As both the 1979 Business Week article and Tuesday night’s New Hampshire primary show, making predictions about complex systems is an iffy proposition at best, and I don’t think it serves the long-term prudent investor very well anyway. As I said in my last missive, I think some of what is going on right now in the economy and in the financial markets is the giving back of perhaps what never should have been in the first place (i.e., there may have been a little too much economic growth, and with it stronger than expected stock market returns, because there was too much easy money floating around over the last few years).
So, a few things to keep in mind:
- Trying to time the market, by all objective measures I’ve seen, is likely to be a bad bet and, in the end, more likely to cost money than save money.
- Stock market returns tend to occur in concentrated periods interspersed with long periods of flat-to-volatile markets. Miss those few occasional days, weeks, or months when the sun is shining and you can miss out on the bulk of what the market has to offer.
- Except in all but the most egregious periods of market over-valuation (and I don’t think this is one of those periods by any stretch), I strongly advise a buy-hold-and-rebalance approach.
- The darker things get, the less risk of over-valuation there is likely to be. Said another way, a market that has fallen 10% has less over-valuation risk after the fall than before the fall, and a market that has fallen 20% is likely to contain less over-valuation risk than it did when it had only fallen 10%. Or, indirectly, said another way: it’s always darkest just before dawn.
- Almost all of our client portfolios are structured such that in an exceedingly bad 12 month market period, they could potentially see a potential downside of 20% or more, and some clients (those 100% in equities) have portfolios that could see a downside of 40% or more. This despite being very well diversified. So, when (and not “if”) that eventuality materializes, as it inevitably will at least once in every client’s lifetime, it shouldn’t come as a shock. That said, when we run retirement projections for clients, we know this eventuality will occur and we have factored such a certainty into the projections. It’s an evitable part of the investing experience, and it’s impossible to separate market returns from market volatility.
- Finally and most importantly, I view the process of investing for a lifetime of independence as a long-term journey. Regardless of whether you are 40, 50, 60, or 70, the greatest risk for most retirees is the possibility of declining purchasing power and/or running out of money. I sincerely believe that equities are an essential part of every portfolio and are the part most likely to drive long-term returns and long-term purchasing power, despite their inevitable short-term volatility. Since this is a long-term journey we are on together, it is important to keep the focus on the beacon that a long-term perspective provides us. I don’t think there is any way to navigate around the inevitable storms that the market suffers without the risk of sacrificing long-term returns and long-term purchasing power. So, know that you have a well-diversified portfolio, that these storms are an inevitable part of the investing experience, and that, over the course of a lifetime, a long-term perspective is the prudent perspective.
As always, please let me know if you have any questions or if there is anything I can do for you.