Stocks are Still a Good Idea

I risk stating the obvious when I say that economic times are still tough. The recession, as the term is strictly defined, ended last summer. But that just means that the economy stopped contracting. The environment is still plenty challenging, even if it is a tiny bit less challenging than it was a few months ago.

So it feels a little strange to be discussing the first birthday of the bull market. Most people are not comfortable even calling it a bull market, using paler terms such as rally or recovery. But in any other economic context it would be hailed as a great and wondrous upswing that we have all been lucky to live through.

The S&P 500 closed at 682.55 on March 5, 2009. That turned out to be its low for 2009, and indeed for the decade. It was a level last seen in September 1996. In other words, with dividends ignored, the market had on average returned nothing for thirteen years.

As evidenced by that market low, last March was the peak of economic fear and pessimism. The banking system seemed liable to collapse, unemployment was rising fast, the housing market was in a tailspin, and nobody, not consumers nor businesses, was spending a dime more than was absolutely necessary for anything.

But unless a person was willing to assume a true doomsday scenario, the stock market was then compellingly cheap by just about any measure. (I listed some of them a year ago.) As some wag put it, and I wish I had an attribution for this, "Either the market is a screaming bargain or the world is coming to an end. Well, if the world comes to an end I’m going out fully invested."

Of course, the world did not come to an end, and as confidence built that it would not, the market staged one of its greatest rallies ever. On March 5, 2010 the S&P closed at 1138.70, a one year return of 66.83% before dividends. For most of us, that is a once-in-a-lifetime 12 month gain. The runner up in modern memory is the year ending June 1983, at the start of the 1982-2000 bull market era, in which the S&P gained 52.94%.

And just as most of us had never seen a gain like that before, and likely never will again, virtually all of us missed out on taking full advantage of it. Somewhere there is somebody who got out of the market in the fall of 2008 and then jumped in with both feet in March 2009, but for everybody else the 67% gain is more theory than reality.

Last Friday the S&P closed at 1149.99. That is a little lower than the close on October 1, 2008. And a little higher than the close on November 18, 1998. For most investors, who lack market timing skills and nerves of steel, the 67% run-up gets lost in what is on a longer term basis a very disappointing period for the stock market.

The market is, in my not-so-humble opinion, still fairly cheap. It is hard for me to get my head around the idea that corporate America is now worth the same as it was 11 1/2 years ago. A reasonable person might argue that the market was way too high in 1998, but I am not one of those people. And it would have to have been very overvalued back then in order for today’s level to make sense. If nothing else, inflation has pushed prices up about 33% since 1998, so in real terms the S&P is now about a fourth lower.

Despite the recent glory and present cheapness, I do not perceive much enthusiasm for the stock market these days. Indeed, it is the recent glory and cheapness that is psychologically working against it. Most people do not look at a 67% one-year gain and invest expecting another one. On the contrary, they view 67% as an anomaly. It is either a one-time correction for a one-time problem, or an implausible and unsustainable gain that will no doubt have to be at least partially undone soon.

And the relative cheapness of the market, the fact that it is now where it was 10-15 years ago, tends not to fill investors with optimism. The "Lost Decade" just ended has caused many to question the primacy of the stock market in mainstream investing. On balance, that is probably a good thing. The stock market is not, and has never been, free money. The truly historic 1982-1999 period, in which the market was up 16 of 18 years and averaged 14.8% annual return, gave a generation of investors unrealistic expectations.

But the stock market is still just about the best thing available for ordinary investors. It should not be the only place to invest, and probably should get a lower allocation than has been recommended by most pundits in the past, but over the long run it can still be expected to be the highest returning investment that most people are able to make. (And, not at all coincidentally, also the most risky.)

Now is a scary, or at the least uncomfortable, time to invest in the stock market. At the risk of cliché, it is worth citing the truism that in hindsight the best times to invest were always the times of lowest confidence. It is the times of high confidence, when putting your savings in the market seems like a no-brainer, that tend to lead to tragic events.

Investing | Frank Curmudgeon | March 15, 2010 11:59 am

No Comments

By Steve, March 15, 2010 @ 12:51 pm

I had a friend who used to say “I earned more this month on my house than I did at my job.” He stopped saying that at some point…

In the last year I earned more in my portfolio than I did at my job. But since my crystal ball wasn’t working, all that I had in the market was what was in there before it crashed. I didn’t bother to state the above. All I earned was (some) of my own money back.
By Dan, March 15, 2010 @ 2:30 pm

I clearly recall that period in March ’09. And my thinking at the time also was something along the lines of the world coming to an end or that it was significantly undervalued.

But the problem was I had started grad school in Fall ’07, and accumulated some credit card debt while I was hunting for the job I started in January ’09. So for me, the real question was whether or not I should be borrowing money for that endeavor… I chose not to. There was no guarantee that the correction/recovery would happen so quickly, and likewise, I wasn’t about to pay an 11% APR to figure it out.

As for the investments I did have at the market peak, I did let them sit. And they’re still sitting there. So the end result is my investments are down about 22% from their maximum value (I was contributing to my 401k up until Sept ’07 and my Roth through Feb ’08.)
By Craig, March 15, 2010 @ 3:14 pm

2009 was certainly a historic year to be in stocks. My overall portfolio was up by over 30% for the calendar year, so like Steve, I made more there than in the office. And as I say, that’s the calendar year. It would be fun to figure out my return on the twelve months just ended, if largely pointless.

But I can’t pretend I didn’t lose a _ton_ of money in 2008. I’m only grateful that I was able to take a deep breath and keep buying all through the bottom of the market. A year ago, my retirement spreadsheet was signalling at least a Yellow Alert, if not the full Condition Alpo for my golden years. Today, things are more or less on track. That’s a good feeling, too.
By kyrgfpl, March 15, 2010 @ 9:18 pm

“over the long run it can still be expected to be the highest returning investment that most people are able to make. (And, not at all coincidentally, also the most risky.)”

The “most risky” part merits quite a bit more space than a mere afterthought. The fact is that people who are relying upon historical equity returns for their retirement are the people who can least afford the risk. Those people should be spending less and earning more, not investing in equities.
By tom brakke, March 16, 2010 @ 9:14 am

You said:

“A reasonable person might argue that the market was way too high in 1998, but I am not one of those people. And it would have to have been very overvalued back then in order for today’s level to make sense.”

I’m interested in a further explanation for that, since by historical measures the market was overvalued then (and, as routinely happens, overvalued markets lead to subsequent poor returns).

Without regard to your views today, I’m interested in understanding your historical assessment of that time and why you have reached the conclusion you have.
By Rob Bennett, March 16, 2010 @ 9:52 am

But unless a person was willing to assume a true doomsday scenario, the stock market was then compellingly cheap by just about any measure.

I strongly disagree, Frank.

The fair-value P/E10 level is 14. At the March low, we were at 12. That’s a tiny bit below fair value, certainly not “compellingly cheap.”

The reason why people fall for the spin generated by The Stock-Selling Industry on this sort of question is that people have been fooled by the heavy and relentless promotion of Buy-and-Hold into thinking that valuations don’t matter that much. When you know that they matter, you know that you need to go to credible sources of information on valuations to know where they stand. Not all sources of information are credible on these questions, and those backed by the “experts” in The Stock-Selling Industry are the least credible.

Rob
By mwarden, March 16, 2010 @ 11:51 am

I find it interesting that you acknowledge that the stock market is risky, but at the same time you “expect” it to return highly over the long term. That doesn’t sound risky to me!
By Dan, March 16, 2010 @ 12:55 pm

kyrgfpl,

You are absolutely right, and that’s one thing I never understood about the stock market. “Everybody knows” you shouldn’t invest money in the stock market that you can’t afford to lose, but… we are also told to invest early and invest often (or at least consistently).

I’m 30 years old, make a salary of $70k annually, have $80k in student loan debt, rent (20% down on a reasonable townhouse around here would probably be $70k, which is $70k more than I have for a down payment right now), and have no other consumer debt.

Should I, or should I not be investing my 401k contribution and corresponding employer match into equities? Can I really afford to lose what I am investing? (Invest in risky assets when you’re young! You’ll have plenty of time to make up your losses!) I can tell you, without a doubt, that whatever losses I incur in my retirement portfolio over the years will have a meaningful impact in my quality of life at retirement.
By Monevator, March 19, 2010 @ 9:15 am

Very good point about how the rally not being hailed as the tremendous achievement you might expect following such a return.

It’s being more treated like an incredibly bright child who everyone is a bit uncomfortable around as he bashes out Mozart on the piano. Good in theory, but a bit creepy.

I’m spotting this bias all the time – the media is still in bear mode. For instance, a bank returns to profit and it barely gets a whisper.

Those March 2009 lows – don’t you miss them? I was near fully invested, but I can’t claim the quote. I did write this however (hope you don’t mind the link, please do delete if so): http://monevator.com/2009/03/11/who-isnt-buying-the-market-right-now/

I suspect I’ll be linking to that for years to come, though I stress the absolute day-perfect timing of the post was a complete and utter fluke. I didn’t expect any sudden rally, and think you can’t expect such things.

Around the same time I saw research suggesting stocks could return on average 20% pa after a ‘lost decade’. Something to think about!