Sunday Musings: The True Picture

Mark Hulbert wrote and interesting story called “Lost and Found.” Here are some highlights:

The “lost” decade?

Maybe so.

But, if so, this is not the first time over the last two centuries in which a decade has been lost. And on each of those prior occasions, the stock market “found” itself soon thereafter.

am not the first commentator to discuss the depressing fact that, over the decade ending Dec. 31, the S&P; 500 index produced a loss. Even with dividends added back in, the index lost 15%, or 1.6% on an annualized basis.

But few of those commentators have noted that, depressing as the picture is that is painted by these statistics, the true picture is even worse. That’s because, over the last decade, the Consumer Price index rose by more than 28% — equal to about 2.5% annualized.

This means that at investor who put a lump in a stock index fund at the beginning of 2000, and held it until the end of last year, lost ground at the rate of around 4% per year. What a shock to investors who blithely assumed that ten years were more than long enough to provide assurance that the stock market would outperform inflation.

But investors at the beginning of the decade should have known better. If they had carefully studied the historical record, they would have discovered a number of past ten-year periods in which the stock market produced a negative real return.

The most recent such period was the summer of 1982. According to an analysis I ran on data compiled by Yale Professor Robert Shiller, the stock market’s trailing real return that summer was minus 3.6% annualized. The other “lost” decades that suffered the largest inflation-adjusted losses include the one ending December 1974 (when the trailing ten-year real return was negative 2.7%), August 1939 (when the trailing return was negative 3.3%) and June 1921 (when it was negative 3.1%).

While there is some solace in knowing that the decade we’ve just suffered through is not unprecedented, the good news is that, in each past case since 1870 in which the market’s trailing ten-year return was negative, its inflation-adjusted return over the subsequent ten years was positive.

This has held true even during decades of high inflation, such as the 1970s. Consider an investor who put a lump sum into the stock market in late1974. He would have been well behind inflation during the latter part of that decade, of course, when the consumer price index was rising at double digit annual rates. But, for the full decade through the end of 1984, this investor would have had an inflation-adjusted total return of 5% annualized.

To be sure, there is no guarantee that the future will be like the past. It’s possible that the stock market could produce two negative real return decades in a row.

[Emphasis added]

I did not know these stats but found them noteworthy. On the other hand, as an investor, I would not want to wait to find out whether the dubious record of no two losing decades in a row will be repeated over the next ten years.

What killed this past decade were a total of some 3 years of bear markets, which simply overpowered the remaining bullish 7 year period. That supports my long-held view that, over the long term, it is far more important to control downside risk than participate in every bullish period.

Investors never seem to grasp that concept in that they constantly try to find the latest and greatest ETF or mutual fund. Or worse, they align themselves with a well known name fund manager as if he could save their portfolio when a bear market strikes. 2008 has proven the fallacy of that type of allegiance.

Viewing the current economic landscape, I find it doubtful that there will be not at least one severe bear market rearing its ugly face over the next ten years. I personally am aligned with those who believe that the “w” concept (moving in and out of recessions) is virtually a guarantee.

Make your plans accordingly. Do not ever assume that you can make an investment and hold it through thick and thin—the market will teach you an expensive lesson.

Following trends and using sell stops is the only way I know of to avoid a portfolio massacre. Despite this losing decade, many have not learned that lesson and are doomed to repeat history.

About Ulli Niemann

Ulli Niemann is the publisher of "The ETF Bully" and is a Registered Investment Advisor. Learn more
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