Now They’re Just Piling On!
Cover Story, by Mark Robertson, Managing Partner August 1st, 2012
Recessions, pending recessions and imagined recessions wreak havoc. Period. Cue the Jaws soundtrack. Read on.
August greeted us with the proclamation from PIMCO Bond King Bill Gross that equity investing is dead. No, I’m not making this up. On the heels of last month’s Death of Equities exploration, we’re committed to exploring Part II and continuing the series this month. We’re centered on EXPECTED RETURNS. If Bill Gross is right, there’s no need to get out of bed. Pass the oatmeal and merely wait for the Mayans to be right. Ted Brooks said it best on the MANIFEST Forum when pointing that when Gross tiptoed back to 1912 to make his point: “Watch it Bill, re:1912 … you’re on my turf now!” Recessions, pending recessions and imagined recessions wreak havoc. Period. Cue the Jaws soundtrack. Read on.
Go ahead and try to pretend that you don’t recognize these adorable stuffed animals. We know better. We were once offered several hundred dollars for one of their ‘cousins’ (I believe it had something to do with a rare platypus.) In any event, rather than disturb our daughter’s carefully constructed collection, we declined the offer.
When it comes to getting “beaned,” we know that it’s just us — my wife and I, clubs we’ve loved and our closest friends. You would never surrender to temptation or swerve to avoid logic, choosing instead to embrace emotion, when it comes to investing. You have a “Tulip Oath” embroidered and hanging in the form of a tapestry on your mantle. It’s right next to the “Up, Straight and Parallel” quilt.
We’ll soon know if the Mayans were right about the end of the world (December 2012) and let’s face it, if the world is really winding own, we can pay a lot less attention to our portfolios. The reliable pendulum of market gyrations can’t extend to extremes without a little help. Hence, we’re rather consistently immersed in hysteria ranging from wide-eyed exuberance to white-knuckle oblivion. Here’s an idea: Discover a few high-quality companies with outsized return forecasts. Check to see if they fit your long-term portfolio. Own them as long as it makes sense to do so. New? Normal? Is it different this time? We don’t know. But it’s certainly normal to wonder and there’s nothing new about that.
Cult Dissing?
Dan Hess summarized the Bill Gross commentary very well.
(1) The 6.6% [real] returns of the last 100 years are not likely to be repeated.
(2) Bonds could return 2% … stocks 4% … a diversified portfolio 3%.
(3) The stock market is a Ponzi scheme.
The Cult of Equity is over and the Cult of Inflation is just about to begin.
Hold The Phone & Slam The Door!
He could be right. But when Gross starts dissing one of our favorite “cults”, our community of committed long-term investors, it’s here that we join Ted Brooks and draw a line in the sand. “What’chu talkin ‘bout, William?” (with a certain nod to Gary Coleman and Different Strokes)
As Hugh McManus has pointed out, it’s important to explore and the lessons of 1873 and the stock market fiascoes of 1907. But as you know, we’re disinclined to place a lot of guidance-emitting emphasis on anything prior to 1941, the advent of the modern stock market. We’ll take a closer look at modern trends. Ted Brooks is skeptical about the relevance of several of the points discussed and clearly establishes that there’s very little new and different — although normal to wonder — about this stuff. “Back in 1912, Lawrence Chamberlain (the “bond guy” of that era) — regarded stocks as “not an investment.”
Chamberlain urged that since there was no guarantee of return of principal nor guaranteed dividends, stocks were clearly vehicles of speculation.
Brooks continues, “Then, in 1925, Edgar Lawrence Smith rocked the investment world by saying stocks had a history of outperforming bonds under all economic conditions. He correctly identified the reason: retained earnings effectively redeployed (invested) in growing the company generated compound growth, which was not available in bonds.”
“The theory of long-term buy and hold growth stock investing was born.”
From Turf Toe to Hysteria?
Well done, Ted. We’ve seen this from Bill Gross before. Specifically, his announcement that PIMCO was not just exiting — but shorting — U.S. government bonds at an investment conference in Chicago a few years ago secured his position in our Grumpy Hall of Fame. Let’s just say that he did it well.
For what it’s worth, that idea doesn’t seem to be working out very well. At least not yet. Turf toe makes everybody grumpy. We hope the turf toe bout ends soon and that he and Mohammed El-Erian can find something to be optimistic about.
History? Really? Really.
We decided to take a look at long-term stock market performance and trends to see if we could help with the remedy. For a closer look, and something of an acid test, we took a look at annual, 3-year, 5-year and 10-year rolling averages for the Dow Jones industrial average since 1920.
Long-Term Cyclical Rates of Return. An analysis of stock market returns dating back to 1920 suggests a 30-40 year time frame for long-term cycles. Where the average annual return since 1941 remains at 10.5%/year … an analysis of rolling 10-year averages reveals some of the concern expressed by Bill Gross and others. Will the next peak resemble the levels seen in the late 1950s or late 1990s? Trending anything cyclical is always a challenge but the 6-7% figures cited appear to have merit.
Different This Time? Really? This ticker tape worship from the January 1929 edition of Forbes magazine shows that exuberance is precedented. So is malaise.
(1) Jeremy Siegel used the S&P 500 in Stocks For The Long Run. We’ve used the Dow 30 for these purposes. They’re both relatively confined to larger companies, including a number of non-core cyclicals throughout their history. In a word, getting absorbed in a large-cap index (no matter how many companies is involved) is not very inclusive or complete when it comes to analyzing the efficacy of long-term investing. Using 100 years may be convenient, but it might be vulnerable. Why? Because trending cyclical stuff is a problem when dealing with partial cycles (think peak-to-trough or trough-to-peak.) With an apparent cycle of 40 years (see accompanying chart) … 100 years is inconveniently 2 1/2 cycles. There’s merit to a 6-7% expectation. But the years to the right (2012-2020) are a work in progress. What will that next hump look like? How high? When? Keep in mind that rolling those 2008 and 2009 results out of the rolling average is going to feel pretty good when the time comes.
(2) The average annual total return since 1920 is 10.5%. Yes, inflation matters, but we’ll keep it simple. We could buy in to 8-9% expectations based on 1-year trending. Yes, we believe selectivity (particularly growth diversification matters … A LOT) and that bonds can help with preservation and achievement of higher returns.
(3) Ponzi scheme? Well … he was striving for visibility. Mission accomplished. There have been literally hundreds of articles and commentaries written about his August newsletter. As far as the cult of equity dying, we think more ink on Wall Street greed, abuses and algorithms merits more attention than GDP.
Stock prices fluctuate. So do returns. So do EXPECTED RETURNS. Invest like there’s a tomorrow. I wonder what the Mayans would think about beanie babies?
Mark Robertson
Mark Robertson is founder and managing partner of Manifest Investing, a source for research and portfolio management focusing on strategic long term investors.