Dispelling Headline Risk With Data…

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Diving right in, Bill Gross, the billionaire bond guru was quoted in this Bloomberg news piece that he is not buying the Trump rally that had small caps rally by 12 some odd percent since the election and the Dow by about 7% and everything seems to be looking rosy. But Gross says that future growth is primarily a function of productivity which has flat-lined over the last several years and shows little promise of accelerating. He goes on to say that the strong dollar and the continual structural headwinds including the aging demographics, deglobalizing trade policies and accelerating debt to GDP in many countries and now the threat of rising interest rates has constrained the productivity at 1% and real GDP at 2%.

Now this is the same Bill Gross who said in the last go around that Dow was going to go to 5000 and probably stay there forever and we all know what happened. So that was a bit of a miss. The problem is that Gross sees things as do most money managers in very short spurts because they care about what happens in short spurts. I do not because I go by the data and we all have the data that shows the markets going through some pretty rough patches but guess what, we all lived to talk about it. So do I care what Gross and other prognosticators say in these various news outlets. Absolutely not.

And he is proposing that investors should move to cash and cash alternatives such as high probability equity arbitrage situations. Oh come on, give me a break. And move to cash? But he is a billionaire so what do I know. But still, moving to cash? What is cash going to get you? Zero point nothing. You have to decide whether you are an investor or a speculator. Speculators go to cash because they are speculating on the fact that they know something that we don’t. They think they know but most of the time they don’t.

On the other end of the spectrum, Larry Light writes in Forbes that he thinks S&P 500 will rise 12% in 2017. Do I care? Absolutely freaking not. And so shouldn’t you because 95% of this does not apply to you as a family. They have no perspective on what your situation is and hence, these headlines are meaningless to you.

Back to the other side again, BofA Merrill Lynch in their global research call says that we might be seeing the signs that the bull market is coming to an end. This is BofA Merrill Lynch, the same Merrill Lynch that almost went bankrupt. They were so smart back in 2008 and now we are to believe that the bull market is coming to an end. So I am reading this and I am saying to myself as to what the heck are these guys talking about. Because they are not claiming that the bull market is coming to an end now but that it would happen in about a year. Their sell side indicator does not catch every rally or decline in the stock market but the indicator historically has some predictive implications for the subsequent 12 month total return for the S&P 500. Then they go on to say that their analysts have a base case call for the S&P to end 2017 at 2300 or about 5% above today’s levels. What? What’s wrong with that? Their base case is 5% up, bullish case is up 20% and the worst case is down 27%.

That’s all interesting but allow me to share why I don’t give a hoot and you should not either because to most of us saving and investing for goals that are at least a few decades out, this is all noise. And if you are still not convinced, you can whip out your favorite data crunching tool and analyze the daylights out of Robert Shiller’s dataset on US stock prices, dividend and CPI history which I did just for you, hopefully serving to allay your fears and all this confusion coming at you from all directions. The stock price data is representative of a collection of large company US stocks comprised within a Russell 1000 or an S&P 500 or a Dow Jones Industrial Average type of an index.

The Tale of A Hundred Dollar Bill…

So if you had a hundred dollars that you invested in a collection of US stocks back in the January of 1950 and just left it there, that single hundred dollar bill turned into about $120,000 by the end of 2016. Not hundred dollars every year but just a single 100 dollar investment.

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And you can see the impact of reinvesting those pesky little dividends. But you say, what was the true, inflation-adjusted increase in wealth of that hundred dollar bill? That’s $11,500 with dividends getting reinvested as opposed to a mere $1,300 without dividend reinvestment. Your purchasing power increased by 115 times with dividend reinvestment versus only 13 times without reinvestment. That’s big. Now granted, 66 years is a long, long time but that amount of time is not completely unreasonable for someone just coming out of school and making that first investment. Life expectancies as we all know are on the rise and a plan that takes into account this long a time-frame can and should be considered prudent.

But what if you had a very generous grandfather or a great-grandfather who had that same hundred dollars invested in the same investment but this time, not in the January of 1950 but in January of 1900. That investment for 116 years and its impact…

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That single 100 dollar bill turned into 5 million bucks ($4.7 million to be precise but who’s counting). And you see those lines hugging the x-axis. Those barely visible colors are for the amounts without dividend reinvestment and inflation. Most of that gain is from dividends getting reinvested. Granted that companies back then were very generous with their dividend payouts, oftentimes disbursing 5 plus percent in a given year but still that reinvestment of dividend is a big, big deal even now.

But then you say that most of that gain happened towards the later part of the 20th century with the value of that $100 barely moving before 1950. Not really. The plot below is a magnified view of the period between 1900 and 1950.

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And we have all studied history enough and despite all the harrowing things the world endured during that time, you still did fine.

Now back to a few statistics I was able to extract from the returns data since 1950 that would hopefully diminish the significance of all these market forecasters you see and hear…

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  • The worst one month decline over this 66 year period was 20.4% but in 11 months from the start of the decline, you were back in the game. 11 short months. You cannot wait 11 months? If your portfolio declined by more than 10%, the average decline was about 12.4%.
  • The worst 3 month decline was 30.7%. That happened once in this 66 year period and in 29 months or about two and a half years later from the start of that decline, you were back to where you started from. Oh sure, with all your research and insights, you could have anticipated that and you would have sold in time just before the start of the decline and got back into the market at the bottom before the ensuing recovery. And, I have a bridge to sell in San Francisco that might interest you.
  • If your portfolio declined by more than 10% over any 6 month period, the average decline was about 17.9%. Worst case decline was 36.8% and it took just 20 months from peak to valley and then back to peak. Sure, 36.8% would have felt horrendous but then you lived through it and survived.
  • Your portfolio experienced the worst 12-month decline of 41% but you were back to where you started from in less than 3 years. Yes, 3 years is a long time to wait but so what. You again lived through it and if you are an investor and you can’t stand these kinds of stretches, you should not be in the market at all.
  • The worst 3 year decline was 39% and it took 128 months or about 10 years…10 long years for your portfolio to get back to where you started from. Actually your portfolio did recover but then the housing market crash caused it to go down again.

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And we lived through it. I lived through it. We all lived through it. The start of that decline was the first year I enrolled in a retirement plan at work and I never stopped. But looking back, this 10-year stretch with the domestic large company stocks not doing much was a great boon though it sucked living through it but the value of all those little investments I made during those years is quite a bit higher than what it was back then. So I am happy but then I am not. Because I am still working and I am still making those same contributions and now I am having to buy the same shares at much higher prices.

And all the bad things in the market happened in the decade of 2000. Well, at least with US large company stocks. If you had a diversified portfolio that included small company stocks, fixed-income investments, international equity and other asset classes, you did fine. Actually you did a lot more than fine because international stocks and bonds trounced domestic only investments by a sizable margin that decade.

But back to the data at hand, one can claim that all these stock market declines since Jan 1 1950, 66 years is a pretty good litmus test about how the markets might respond over the next 66 years. They might but there is no certainty. Because…

  • United States was an emerging market, enjoying growth rates far higher in the early part of the 20th century than what is possible today.
  • Post the Second World War and with the rest of the world almost destroyed, the United States was in a catbird seat and businesses in this country helped rebuild the rest of the world. Businesses profited which in turn reflected in the country’s stock markets.
  • Interest rates where they are today have nowhere to go but up and part of all the gains over the last couple decades could be attributed to businesses enjoying cheaper and cheaper access to capital due to declining interest rates which translated into increased profits and hence higher stock prices.

So the future is uncertain. What do you do then? You diversify. You own large company stocks and small company stocks, you own international and emerging market stocks, you own growth and value stocks, you own bonds and commodities and real estate. Because that is what is going to work and that is what worked even during the so called “Lost Decade”.

Happy Investing.

Image credit – Swallowtail, Flickr