Bubbles, Bull and Bears

On May 15, 2014, the Dow Jones Industrial Average dropped 1.6%.  The decline was attributed to a bearish comment made by a well respected investment professional, David Tepper.  “I’m not saying go short, I’m just saying don’t be too fricking long right now,” he said.

Another successful investor, Jeremy Grantham, wrote recently in his investment newsletter, “I am sure it will end badly.”  He tempered his comments by suggesting the inevitable downturn might be a few years off.

Characteristically, the stock market is sending conflicting signals and caution is widespread.

As a backdrop, keep in mind the path that the Dow Jones Industrial Average has taken since 1981 when it was then at a level of about 1,000. It moved past 9,000 by early 1999, eclipsed 14,000 in late 2007, and plummeted to 6,600 by March of 2009. The Dow Jones Industrial Average now sits around 16,600.

A few observations:

A point-to-point measurement of the Dow Jones Industrial Average for the last 15 years yields a total return (including dividends) of just over 5% per year, which is about 50% below the long-term average since the start of the 20th century.  Relatively poor investment returns are often followed by outsized returns and vice-versa.  From 1981 to 1999, stocks had great returns.  From 1999 to 2009, stock market returns were quite poor. Clearly, the last 15 years have seen significantly below average returns.  Hence, draw your own conclusions.

Stock prices move in fits and starts. Large moves take place within a fairly short time period and hence, gains and losses.  These can be quantified in days or maybe weeks. A Google search can muster up the data, so I won’t make this essay any longer by repeating the information.  That said, I cannot count the number of times I have heard investors say that they are going to “sell their stocks” as trouble hits and wait for the “all clear” before reinvesting.  Candidly, following this rationale, one would probably have sold all stocks in late 2008 or early 2009 at a level on the Dow Jones Industrial Average of about 6,500-7,000 and then repurchased a year or so ago when the Dow was at about 15,000.  Nobody rings a bell at market bottoms and tops!

The most important observation is the misplaced notion that bearish (or bullish) news, that has already made its way into the public domain, has not yet affected financial asset prices.  Wrong. It has.  When investors read about something in the newspaper or see it on television, millions of other investors are also simultaneously reacting to the news.  Market prices immediately adjust to the fresh “news.”

It is therefore the “surprises” that move markets, and by necessity, they cannot be predicted (or they would not be surprises!).

Looking ahead, and armed with this knowledge, if I were forced to make a forecast, I would suggest that the current general uptrend in common stock prices will persist perhaps for another 5 to 10 years.  Most secular bull markets last 10-15 years and most secular bear markets last about 7-10 years.  The current bull market was born March 9, 2009.  There is nothing magical about these time frames.  It is the typical period required for those with the most unassailable faith in common stocks to have that faith shattered and for the most ardent skeptics to become convinced to own stocks.  My mentor, Chuck Ricker, used to label this process, reflecting investor psychology, “Complacency, Concern and Capitulation.”

Over very long periods of time, stock prices react to the accumulation of corporate earnings.  The way in which investors react, or value those earnings, vacillates based upon psychology.  Warren Buffet put it differently, quoting his own mentor Ben Graham in saying, “In the short run, the market is a voting machine, but in the long run it is a weighing machine.”

Ultimately, an investor’s allocation to common stocks is more dependent upon his or her personal circumstances rather than the current level of the stock averages. This is how Sigma Investment Counselors advises clients.

All comments and suggestions are welcome.

Bob Bilkie, CFA