By Steve Blumenthal, CEO, CMG Capital Management Group
According to my friends at Ned Davis Research, Inc., during the average buy-and-hold stock market, an investor spends 77% of his or her time recovering from cyclical downturns in the market. 77% of the time – that’s telling. It’s in the mathematics of loss. Remember that it takes a 100% gain to overcome a 50% decline.
My two cents is that many investors expect 9% to 11%; yet, we currently live in a world of 4% to 5%. If you are an older dog like me, you’ll remember your clients expecting 18% per year or more in the late 1990s and 2000. My client, Roberta, left CMG in December 1999 after I grew her account 30% over the prior two years. She was ultra-conservative and positioned accordingly.
The problem, of course, was that 30% paled in comparison to the 51.4% the S&P 500 gained in 1998-1999 or the 159.14% the NASDAQ gained over those two years. She told me she was going to a Merrill Lynch broker and was investing in “safe stocks”. Her $1 million account fell to less than $500,000. Had she stayed, that same $1 million would have grown to over $1.3 million. It is tough to compare a conservative bond strategy to stocks, but I showed her the forward return probabilities back then and I wrote frequently about a technology bubble. Unfortunately, that didn’t help. She was in her mid-60s then. Safe stocks. Right.
As a quick aside: Do you remember those NASDAQ gains in 1998 and 1999? An interesting data point is that more than three quarters of all the money invested in Fidelity mutual funds was concentrated in their technology funds. The NASDAQ crashed some 75% by mid-2002 and has only just recently crossed back above 5000. It took about 15 years to get back to even but who was really able to ride that bumpy ride back. The bigger question is: Who took advantage of the buying opportunity that crash created?
I believe we can get a good fix on what forward returns will be. Take a look at the following from Rob Arnott’s shop. His research shows that by knowing the beginning dividend yield, EPS Growth and Implied Inflation, one can fairly accurately predict the Expected Equity Return over the coming 10 years.
Though the data doesn’t perfectly align to the above decade chart, it is close enough in my book. Take a look at the Expected Equity Return for the 2001-2010 10-year period of time. In 2001, the expected forward 10-year annual return was 4.7% per year (orange arrow next chart). Not 9%, 11% or the 18% many were hoping for. The actual compounded annual growth rate or return, using the source calculator for the S&P 500 Index was just 1.36%.
A 10-year time frame is one thing but zeroing in on what returns might be over the next year or so is far more challenging. I take a crack at that too this week with another great valuation chart from NDR (hint: the result is negative over the coming 3 to 24 months).
Let’s also take a look at what has been driving the market higher. Some argue that individual investors are still on the sidelines. I don’t think so and I show evidence that they are almost as fully invested as they were at the 2000 and 2007 market peaks. So if they are nearly “all-in”, who’s been pushing up prices? I include a note from Art Cashin this week – it is corporations buying their shares back and taking on more debt to do so.
See the rest of the story and important disclosures in On My Radar: Rut Ro Rastro
Steve Blumenthal is CEO and CIO of CMG Capital Management Group. The objective behind all of Mr. Blumenthal’s work is to help advisors build better portfolios by allocating with a long term game plan that is risk sensitive and properly diversified. Mr. Blumenthal is a self-proclaimed “quant geek” with an analytical mind for the markets that helps him connect with everyday investors and industry experts alike.