Share markets have long been considered the best asset class for wealth accumulation. The investment industry adage is that, in the long run, shares always go up.
The following graph from Fidelity Investments is an oft-used example of the recuperative powers of the Australian (blue line) and global (red line) share markets.
Source: Fidelity Investments
Over the past 30 years (this seems like a reasonable period of time to test a theory), the market has shrugged off a number of setbacks: 1987 Black Monday, 2000 ‘tech wreck’, and Lehman Brothers in 2008. And the US market is on its way to higher highs.
What more evidence do you require?
How about a much longer-term picture of the US market?
US investment firm First Trust Portfolios LP has published the graph below: History of US Bull & Bear Markets Since 1926.
Now, 90 years of performance definitely qualifies as the long run.
Source: First Trust Portfolios
What do you see?
The blue (bull) far outweighs the orange (bear). That’s the illusion.
To quote, from the graphic:
- The average Bull Market period lasted 8.9 years with an average cumulative total return of 490%.
- The average Bear Market period lasted 1.3 years with an average cumulative total loss of -41%.
The average investor would look at this and conclude that investing in stocks is a no brainer.
In fact, you’d have to be plain dumb not to invest in shares.
Let’s dig a little deeper to test the veracity of the ‘first blush’ response.
In the fine print of the graph, there’s this disclaimer (emphasis mine): ‘Investors cannot invest directly in an index. Index returns do not reflect any fees, expenses, or sales charges.’
You may be thinking that investors can in fact invest in an index fund. That’s true. However, the data used to compile the graph is the index return BEFORE any fund fees have been deducted.
While index fees are relatively low, not including them in the data overemphasises the gains and understates the losses.
That’s the first point.
Secondly, the upside percentage will always be greater than the downside. A long-term bull market can rise several hundred, or even thousand, percentage points.
On the downside, the absolute maximum a market can fall is 100%…once a market falls 100%, there is nothing left.
While quoting ‘return of 490%’ and ‘loss of 41%’ is technically correct, it can be misleading.
Next, I put some numbers to the peaks and troughs to better illustrate this second point…I hope my writing is legible enough.
Source: First Trust
Starting with $100 in 1926, the value increases to $293 in 1929 (193.3% gain over a period of 3.7 years).
Less than three years later, the value falls to $49 (after suffering a loss of 83.4%).
What if we stopped the graph here and reported the following findings?
- The average Bull Market period lasted 3.7 years with an average cumulative total return of 193%.
- The average Bear Market period lasted 2.8 years with an average cumulative total loss of -83%.
The average punter would think that they’re still ahead 110% ($193 minus $83).
Seriously. Don’t laugh. People get bedazzled and bamboozled by numbers.
At the start of 1960, the value was $2,930. It took nearly two decades for the market to reach this level again.
Those three ‘little’ downturns of -22.3% over six months, -29.3% over 1.6 years, and -42.6% over 1.8 years took the wind right out of the share market’s sails.
The market was becalmed for years.
This period is better known as the Secular Bear Market of 1966 to 1982.
After 1980, the blue periods recorded some extraordinary gains. These bullish periods were disrupted by the market downturns in 1987, 2000–03 and 2008–09.
The current market high makes the bullish case appear to be more compelling than what it should be.
At the peak of the ‘tech boom’ in 2000, the value was $113,575. Today it’s $156,685.
What do you think the compound rate of return over the past 16 years has been?
A measly 2% per annum. Add another 2% for dividends from the S&P 500 index, and the return from peak to peak has been a little over 4% per annum.
Why has that return been so pedestrian? Because of those two ‘little’ orange dips of -44.7% over 2.1 years and -50.9% over 1.3 years.
When you suffer a fall of 50%, it takes a gain of 100% to recover your capital.
There is another orange dip coming — perhaps this year or next — and it has the potential to be far worse than the average loss of -41%.
The loss could be somewhere between the average and the 83.4% loss experienced in 1929–1932.
A 60% loss would wipe $94,000 off the value, leaving a value of $62,000.
This is the amount recorded in early 2000 after the ‘tech wreck’. Should this eventuate, it would mean nearly two decades of ‘going nowhere’…hardly a bullish outcome.
The charts by Fidelity and First Trust are typical of the industry’s marketing efforts to downplay the risk and overstate the rewards.
What the industry charts do not tell you
The Fidelity and First Trust charts (as well as the entire investment industry) rely heavily on the post-1980 period to create the illusion of ‘in the long run, shares prevail’.
What the investment industry charts do not tell you is what propelled the market higher over this period.
The private sector’s indulgence in debt ‘just so happened to occur’ at the same time as the greatest bull market in history.
Was this just a coincidence?
This was a debt binge without peer.
When looking at the industry’s charts on the wealth-creation powers of the stock market, you need to ask a few questions. Namely, can the factors that created the multiplier effect in the economy and financial markets be repeated again? Or will the absence or withdrawal of those factors have an equal and opposite effect?
The other point to note is the CAPE 10 PE in 1982 was around seven-times. Today it’s 28-times. This fourfold expansion in the PE multiple has made a substantial contribution to the market’s outperformance over the past 35 years.
Can the PE continue to expand? And can earnings continue to be generated from a consumer willing to go deeper and deeper into debt?
I think not.
I am not anti-stocks. I am anti-propaganda.
I genuinely believe there will be a time to buy shares with all the gusto of an avid bull. However, in my opinion, now is not that time.
The investment industry is largely a ‘one-trick’ pony. Its relevance rests heavily on the share market outperforming cash. Everything that comes from the industry has to be viewed through the prism of self-interest.
When the next orange dip occurs — one that I think will be longer and deeper than the average — the industry will be confronted with a crisis of confidence. When the one and only pony in its stable goes lame, what ‘show’ will they be able to sell?
Editor’s Note: The above article is an edited extract from The Gowdie Letter.