A reader who works in the industry emailed me over the weekend and commented that he believes "the future for investing will be much different than the past."I generally follow the line of thinking. I have been writing about the evolution of investing from the start of this site, exploring the merits (or lack thereof) of new types of asset classes and have implemented a couple of these types of investments in client accounts.
That the investment world is changing is something I can buy into but it is difficult for me to wrap my head around the idea that a bell rang in late 2007 marking the end of equity investing as we know it. My expectation was that over a longer period of time equities would become less compelling for an extended period consistent with my past comments about equities averaging closer to 5% over time not 10%. Further I would have expected such a transition to be much quieter than the fast 50% decline for the broader averages.
Reading that a shift away from equities should theoretically be slower and quieter you might reply that the shift is not over the last 15 months but the last ten years. That might be correct of course but cutting in half as we did from 2000-2002 was not unprecedented. The market does that every few decades but never twice in a decade (that I am aware of).
While the second 50% decline this decade works against my thesis I had one thought that supports equities not being dead. As the current bear market started in 2007 market participants had a certain knowledge of history and truisms of how markets work and many people in the market in 2007 were also in the market in 2000. However there were far fewer people in the market in 2000 than were in the market in 1973. Point being that if you have survived a 50% decline previously you are less likely to be scared out when the next one comes along.
The fear created in 2002 was new for enough people that it allowed for emotion to peak and stocks to bottom. The fear created by the second 50% decline is less than the first one which prevents emotion from peaking at the same level as before so it prevents stocks from bottoming at the same level. Put differently, perhaps we need a lower level on SPX to create the same fear that created a bottom in November 2002.
If this is true then it may not be the end of equities just a larger decline to create the bottom. FWIW I do not believe it is the end of equities, I believe returns will be lower than average which is not the same as the end of them altogether. To be clear about one thing this post is an exploration of market psychology not a discussion of the current fundamentals.
24 comments:
To make a case for equities, all one needs to believe is that private capital will seek decent returns. As new technological advances are made, new enterprises will need access to capital to expand and exploit their discoveries. If on the otherhand, the government becomes so insistent in punishing private enterprise and heavy-handed in regulation, private capital will be unwilling to shoulder the risk. Once the fundamental function of the equity markets ceases, the secondary market (trading existing shares of equities) will be meaningless.
In my opinion, the survival of equity capital markets is a socio-political one. Perhaps with the massive new role government is taking, the uncertainty of the moment is the driving factor behind the diminishing value of equity markets.
In the end, I believe we will return to a healthy private enterprise system and by extension healthy equity markets. Even the poorest of the poor dream the American Dream and would jump at the chance to earn their way out of poverty. When this ceases in the United States, then we will know the party is over.
Hey Roger. I've just finished reading both Buffett's and Hussman's annual letters, and neither even remotely suggests that equities are dead. On the other hand, neither spills much ink about new types of asset classes. Buffett, in fact, seems to have been burned by venturing into somewhat more exotic finacial instruments.
I'd be very interested in your take on their perspectives, if you would.
Thanks very much.
"In the end, I believe we will return to a healthy private enterprise system and by extension healthy equity markets. Even the poorest of the poor dream the American Dream and would jump at the chance to earn their way out of poverty. When this ceases in the United States, then we will know the party is over."
My god was that refreshing to read. Thank you anon 6:35.
I'm not sure I can jump in the "investing has changed" camp. Maybe it has, but I guess I'll figure it out too late. Until then, I'm sticking to the ol' buy low, sell high.
Bill B: your mantra works perfectly as long as your operating with a daily and intra-daily horizon.
Anon 6.35a... To "earn their way out of poverty" has little to do with the hope that lies behind the eyes of the investors who have just had 50% of their 401ks immolated. That hope is much of what has kept the market still clinging by its fingernails to current levels.
Scroll back on a monthly chart... there is no "consolidation" or support (on a technical basis. We went straight up at a 45deg angle through the early 90s (coming out of the 92 recession).
From here, its possible to freefall for another 1000 Dow points. And with every daily drop, there are more 401k losers that are burnt to a crisp and convinced "never again".
I'm not sure this is a "socio-political" struggle. I think we are coming face to face with "time to pay the piper". The "new" role of the gov't is merely a reversion towards where we were post -'29. Glass-Steagall will reappear in a different guise, and there will once again be a segregation of risks that you can buy and sell.
Healthy equity markets means... what? Tight spreads? (I think what you are wishing for is an equity market with a surplus of buyers, and an implicit positive slope to returns.) This "new" market will likely (in my worthless opinion) be one where risk will find its own level. Equities will be forced, by price, to offer a significant premia to less risky investment positions. The 6% dividend will reflect the payment for the risk you are assuming as the first loss provider.
If healthy equity markets means (to anyone) 2% dividends (due to high prices) and constant capital growth, time to put down the bong and take a cold shower.
R in NY
Rog,
Of course there will always be a market for equities. But I do believe the market could be entering into an extended period of negative to zero returns, similar to the 1960s-70s, where I think the market had a zero rate of return for about 16 years. People forget what the market was like before 1982.
Dave,
"could be entering...?"
dude we are already there, have been there for a while and likely closer to the end than the beginning.
"dude we are already there, have been there for a while and likely closer to the end than the beginning."
We've been there since 2000, so now in the 9th year.
Not so sure about being closer to the end though, especially if you use historical dividend yields as an indicator
http://ih.fotothing.com/81981.gif
the counter argument to the dividend question is that treasury yields are much lower than past instances when yields marked bottoms.
Hi Roger
1930's and 1940's had low T's, high DY's.
http://www.qvmgroup.com/invest/wp-content/uploads/2007/09/rates1.jpg
did not know that--hope that comparison doesn't stand up, crikey.
Div Yield vs Index over that period has a pretty high inverse correlation
http://ih.fotothing.com/81994.gif
The upside is that if a bunny did start in 2000, and we're already 9 years into it, then from
ih.fotothing.com/81995.gif
we might only have perhaps 5 or 6 more years of consolidation to go.
That's more comfortable than having been aware from that start and knowing that you had 15 years to go.
Excellent point about current investors having likely experienced the early 2000's correction, but not the 1972 one.
dead or not, if you knew 18 months ago what you know now, you would be out of equities. Simple as that.
and you would be as popular as Roubini and the new rock star of investment managers.
Is the big issue this time that the real economy has melted down with the stock market - which really didn't happen broadly in 2000-2.
Yeah, the bell rang in 2007 signaling the top, but I had my iPod headphones on.
DRAT.
I doubt things have changed in the investment world. It's just that we smooth out history to produce friendly averages. The shorter term tends to be more volatile.
And just now folks are decrying buy and hold, and dollar cost averaging, as dead.
I doubt it. They're still the best options for most over a long period of time. But most folks severely underperform the market because they get caught up in the short-term headlines.
Just opining, and I could be wrong. My cyrstal ball hasn't been working lately, either.
There's little reasurrance from long-term trends when market is free-falling like it has since breaking s&p 800. Starting to look like a second crash move. I suspect many are now realizing they've underestimated how weak conditions really are. Anyone think we'll see 800 again this year?
Hi muckdog
Most folks under-perform the market because for most of the time not even buy-and-hold nor DCA paces the longer term average. And that’s not just a consequence of costs.
For large proportions of time the market is above fair price level, so there’s a high probability stock is purchased at a relatively high cost, even under DCA. Which has the effect of depleting both capital gain and dividend income benefits.
As current price levels are nearing fair price, we’re at or around one of the less frequent buying opportunities where stock purchased at around current levels is likely to pace (or exceed) the long term average. You have to go back decades however for the last buy opportunity. Anything else bought between those times is likely to relatively under-perform the longer term market average (more so when costs are factored in).
Not to say prices will not go lower, as typically when buy opportunities do arise they often over-extend.
Ironically, the big unions that supported Obama are now receiving their "reward":public pension funds are now seriously underfunded. But that does not bother them a bit.
It has been stated that liberals do not really want fairness and equality, they want power. That's how it works in Chicago, and the transfer to Washington is evident.
Thus, "card check" and Sol Alinsky tactics trump equities and financial growth in what was a capitalist system that worked.
Chicago-style politics fostered by class warfare political strategies will continue to destroy productive capital and investment.
Thanks BHO, for nothing.
The prime portfolio strategy to follow now is tax avoidance for 2009 and beyond.
"...Sol Alinsky tactics trump equities and financial growth in what was a capitalist system that worked."
One shudders to think how bad things would be if the system hadn't worked so well the past nine years ...oh wait.
The big mistake is to believe there is only one model for capitalism or one style of entrepreneurship yet, somehow, restrictions on what constitutes capitalist behavior have proliferated to the point of kitsch: Glitzy imitation substitutes for substance, rote gestures substitute for thinking; if someone can become a virtuous capitalist by merely singing its praises or condemning its critics as socialist demons then the haystack has succeeded in hiding in the needle.
The overt reason for our problems was too much leverage, too much easy credit, but more than anything else it looks like we reached the point where we, the system, basically ran out of creative and useful ways to use that money; so we began buying garbage just because it was there to be bought and others were willing to sell it and produce more of it.
Malinvestment put us here IMO and more good ideas are what we lack. I'd guess we probably need to hear a lot more ideas these days rather than less, and preferably ideas that have some research or other means of support underneath them too, and then it will be time to start rolling again I think. JMO
For what it's worth:
I met Saul Alinsky when he spoke at Case-Western Reserve University in the late 1960's. He seemed to me to be a nice reasonable guy. For a long time I wondered why he was doing what he was doing instead of being a doctor or lawyer, etc. like the rest of us. Then I heard he was being paid $150,000 a year(an enormous sum in those days ). By whom I don't know- but I believe that explains it.
HZilkhah's note on Saul Alinsky reminds me of my favorite quote of all time (well, one of them at least).
It was one of those silly shows where some network clown was doing the rounds on the street asking passersby whether they agreed or disagreed with the phrase, "money is the root of all evil," and why.
Appropriately enough it was a derelict (at least that was what he looked like) who gave the best answer: "Absolutely man! That's why everybody roots for it!"
Now that's an aphorism with some layers to it.
Dang RW, there you go again with your sensible commentary.
As I have said, too much financial engineering and not enough civil, electrical, mechanical...engineering.
Dude, you should be the treasury secretary!
Dyn-O-Mite!
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