Return Assumptions and the Bear

A lot of people throw around terms and assumptions without questioning them deeply. One of the most common assumptions is that stocks beat bonds (and beat the heck out of cash) “over the long haul”.

The basis in fact for this assumption is the long term equity records in the USA, the UK and Canada. These markets, over the long haul, have provided returns beyond bonds and cash.

Why only these markets? Because the rest of the markets (Germany, Japan, China, etc…) had some sort of cataclysmic event (World War, hyperinflation, or takeover by non-capitalist regimes) that make comparisons “over the long haul” useless. Even in these markets it is hard to see how wealth could have been preserved; cash (currency) was debased and debts were reneged upon, so all bets were off.

One key element of the “returns beat bonds and cash” is the assumption that you stay the course through horrendous market periods, hold on to equities, and then ride the upward ticks. If you act as many people do and sell when the market gets difficult, you are apt to be out of the market when it shoots upwards. Some of these bear markets are very lengthy and you have to have nerves of steel to ride them out.

I bought a recent book (in paperback) called “Hedge Hogging” by Barton Biggs explaining how he ran a hedge fund and all that goes with it. Mr. Biggs has been in the markets for a long time, and he started out right as the Bear market of the 60’s and 70’s occurred. From the book:

“I launched Fairfield Partners on June 1, 1965, with $9.7M, $200,000 of which was mine. The Dow Jones Industrial average closed on May 30, 1965 at 912. SIXTEEN YEARS LATER it was at the same level. By 1981 adjusted for inflation , the DOW had lost more than half of its 1965 purchasing power value, even when you added back the dividends that you had been paid.”

In parallel, there was an article in Barron’s on January 21, 2008 titled “Looking Back at the Lost Decade”. Per the article, here is the annualized total return from 12/31/99 through 12/31/07 by asset class:

– 30 year Treasuries 8.77%
– 10 year Treasuries 6.45%
– Dow Jones Industrials 3.95%
– Cash 3.24%
– S&P 500 Index 1.66%
– Nasdaq -4.7%

Since the beginning of the year the S&P 500 has lost another 5.5% or so… a bit more of this would drive the total return for the decade so far into negative territory (and it is punishing the NASDAQ, too).

Remember, this is average total return over the period… for stocks to catch up to bonds (or cash, if current performance is factored in), they’d need a pretty good long run of performance.

The third leg of the post are those recent advertisements I have seen on TV where the guy is considering retirement or whether to keep working. After he thinks about it for a while, he talks to his broker who says “Yes” meaning that he has enough money to retire.

The sentiment of those commercials was echoed in a recent article in the WSJ titled “Be Skeptical of the Hard Sell, Even if it is in the Workplace”. The article describes a 52 year old woman who retired after 33 years as a secretary at Eastman Kodac based on advice from the retirement counselors, Morgan Stanley, who were referred to by her employer.

The conflicts of interest in this area are immense. First of all, the employer often wants the older and more expensive employees to leave, since their rate / hour is higher and they drive up insurance costs. Of course, the employer can’t admit this, since it is illegal, but all things equal.

To say that the broker has a conflict of interest is an even bigger understatement. If you don’t retire, the broker makes nothing. If you do retire, the broker gets commissions (or a percentage of assets, depending on how he is compensated) regardless of whether or not actually retiring is a good idea or not.

To put this in perspective, would you ask your real estate agent whether or not you should sell your home? Of course not… the agent wants you to sell / buy a home so that they make their commission. Everyone realizes that the agent only is compensated if a sale occurs and treats them accordingly; not to say that they don’t offer a service and / or advice that could be valuable, but they are extremely motivated to close a sale one way or another.

How do all these threads work together? Here’s how…

1) a bear market in stocks can last for a LONG time. Even the rosiest stock forecasts for returns assume that you ride out the downturns without selling and then ride the upward wave. If you get out of the market when it gets choppy, then all bets are off, and bear markets can last for decades
2) returns for the last 7 years (and the start of the 8th) have been poor even if you “stayed the course”… if you exhibited typical investor behavior and bought high and then sold after they crashed your performance is likely even worse than average. On the other hand, cash has done quite well and bonds even better
3) a lot of people who glibly make pronouncements about whether or not you can “retire” or provide advice have conflicts of interest that are hard to ignore

I am not saying to get out of stocks and into bonds or cash because I am no better than the next guy at predicting the market. I do know that if you are going to try to earn the high returns that stocks THEORETICALLY offer you need to stay the course when the seas get choppy, even if it takes decades; if you bail out then you might as well stay out of equities entirely and just keep your money in cash and bonds.

When you hear people talk about the assumed better return on stocks you might want to listen with a jaundiced ear and think about whether or not they really 1) know what they are talking about 2) have the courage and conviction to stay the course when it gets rough.

Cross posted at LITGM