The context was the S&P 500 and by extension investor's portfolios. "Come back" can be objective; 1565 on the S&P 500 which was the closing high in October 2007. "Come back" can be subjective; some portfolio level where the investor no longer feels his entire financial plan is upside down.
Anyone who is serious about giving up on stocks needs to realize the point in the cycle at which they have decided equities are not for them; after a 57% decline. Plenty of people were worried/emotional after a 30% decline so at down 57% I do not doubt the emotional toll taken on some participants. But the decision to give up is driven at least in part by emotion.
If after getting your hands around the emotion driving this you still want to give up then you probably need a game plan that involves selling a little bit at regular intervals as the market goes back up--whenever that might start.
This sort of approach would do a couple of things. One is that the stock market will continue to exist, it will continue to go up most of the time and occasionally go down a lot for some reason even if this one is worse and takes longer to start to meaningfully recover. So from the continue to exist camp a systematic sales process would allow recovering a little more than by selling it all now. It would also give you time to let any emotions go back down and maybe look at it a little more rationally.
On the Seeking Alpha version of yesterday's post a reader asked that if 2007 is 1929 then didn't it take until 1954 to get back to even implying, by his math, an average annual return of 3%. In that light why not change your allocation now. As I am in Hawaii I do not have my Stock Trader's Almanac. That disclaimed, this was my reply;
I don't think that (2007=1929). But if you do look at a stock trader's almanac at how huge some of the up years were during that decade, the biggest in the 20th century. Normal stock market behavior, and keep in mind this was exhibited in spades in the 30s, includes large retracements after huge declines. Not to say that we would not go back lower after a huge retracement but there will be a couple of these along the way at some point. Then would be the time to adjust IMO.
For what it is worth I do not think it is the end for stocks. The decline has been severe and there is no way to know how long it will take for this to end. I have opined along the way about magnitude and duration but I am pretty sure I never said that enduring this would be easy and I'm not sure where I would be mentally if I had not taken some sort of defensive action early so there is an element of easy for him to say in this but despite how "different" this event has been the fear is not different and I suspect the emotion that causes feel good rallies is not different either. Hopefully anyone hellbent on getting out can do so smartly but I am not part of the get out crowd.
17 comments:
If investors will not consider stocks now they are falling into the trap that has caught people for ages; it hurts so bad they go to something safe. I was sitting with someone last week that described their move from stocks to treasuries in their IRA. I did not say anything, but they have taken the brunt of the downturn and now move their investments to get none of the future upside. This is like closing the barn door once the cows have escaped!
Stocks have a risk premium for a reason. We are witnessing the reason. Adios.
Hi Roger.
Just to confirm - you did see the graph I linked to yesterday
http://ih.fotothing.com/82533.gif
and that the price scale in that graph is LOG scaled
1800 to 1940 - Flat
1940 to 2000 - Bull
does not 'most of the time' make.
That does not however mean we should give up on equities. Generally stock capital values align with inflation over the longer term, dividends in effect provide the risk-premium. The combination of both is what makes stock investing worthwhile.
at some point going back in time becomes less useful. is it really comparable to look at stock market action from 1830?
If you think it is then i would say that the 19th century was flat and the 20th century and start of the 21st century are cyclical.
I just view the info on the chart differently than you.
The tendency of equity risk premiums to fall in good times and become excessive during bad times can be attributed to the recency (serial position) effect -- the tendency of people to pay more attention to events close in time -- but also to the plain fact that assessment of equity prices is extremely granular, highly imprecise, and any time you have imprecise measurement you get oscillations around a trendline reflecting risk/reward perceptions; the more uncertain market participants become, the larger the oscillations usually.
And it looks like a rather large oscillation upward is beginning now; I'm playing it long in my tactical account but with rising stops. No strategic change unless a clear trend is established and, since big moves are more typical of unhealthy markets, I will not be holding my breath.
Man I should have predicted the market rise today. I scheduled a buy for this afternoon. hahah.
1800 to 1940 did not have the innovations and gains in productivity we had from 1940 to 2000
I am not Rosie eyed going forward, but stocks will come back in a reasonable period of time. Of course we need to stop blowing up this household debt bubble first.
The Industrial Revolution was one of the most innovative and productive times ever.
Bubbles occur over time. 1720 South Sea Bubble. 1845 railway mania etc.
Those who do not heed the lessons of history, are doomed to repeat its mistakes.
Taking a smaller sub-set of a larger whole and basing future predictions solely upon that smaller sample carries risk.
Founding an investment strategy based purely upon expectations of growth equally carries risk. There are alternatives around that can be employed to diversify that risk.
One method to evaluate the risk/reward potentials of a blend of investment styles is to employ Monte Carlo simulations. Another is to use actual historical prices. Where actuals are used but are restricted by recency that has a tendency to distort the output.
Don't get me wrong, I'm not trying to be critical or awkward, just highlighting that investment style diversification is just, if not more important than class diversification - especially so in view of more recent globalisation.
If you have a range of investment styles, one that benefits from growth, another that benefits from sideways ranging and a third that provides downside loss limitation/gains then you are much less under pressure to time the market. Not to say that if the timing proves to be reflective of actuals that the gains wont be higher than that of a more diverse blend of investment styles (equally though the pains might be more intense).
Roger,
For the most part, I agree with you 100%. Now would be a terrible time to get out. Wait for the feel good rallies and then sell.
You talk a lot about emotions and fear, and I think that's smart and timely in this environment. The thing I get hung up on with your posts is not your opinions but the reasons behind them. For instance, you say that you don't think 2007=1929. That's a perfectly legitimate opinion to have, but I'm curious about why you think 2007 is not 1929. Have you done quantitative studies comparing the two periods, do you rely on other indicators, or is it more of a "gut" feeling? There must be one or more reasons behind this hypothesis, and I wonder if emotion itself may be playing a role in your conclusion.
Also, do you ever use stops in your investing approach? As an individual investor, I find stop limits to be a fantastic tool to hedge and manage risk, and that way I don't need to be making big bets on long term movements in the market. On the other hand, I don't know if stop limits are a useful or practical mechanism for financial advisors with larger accounts. Just curious.
Start from where you are and go forward.
Dave I read all day long every day trying to take in as much as I can. I have tried to learn as much as I can about past cycles. I have said this many times over that I try to understand current events add that to what I know of history and try to make a forward looking analysis. I do not do any type of quantitative study or the like. When demand becoems unhealthy I get defensive. If I believe more defense becomes warranted based on current events, which was this case after the intial defensive action on this go around I take it. Myabe that will be enough or maybe not but I outlined what I did when I did on the blog.
Stop orders; I use them occasionally but for my purposes they are less effective when everything is falling a lot. The couple of things I bought have of course gone down but they were bought to capture an upswing when it comes. So buying something for an upswing to only then get stopped out before the upswing does make sense to me. Not to say that in hind sight I shouldn't have waited but that is hind sight.
I find stops more useful in an up market to perhaps indicate when a stock is having trouble versus the market.
Do you (Dave) think 2007 IS 1929?
It seems to me that, while there may be comparisons, we really live in a different world.
The lead up to 1929 saw frenzied buying. Stocks were seen as a one way (upward) street and stock ownership and leverage increased to extra-ordinary levels.
http://ih.fotothing.com/82632.gif
resulting in the Dow doubling, doubling again and doubling again (approx 50 in 1921 to 400 at the 1929 peaks).
The subsequent crash saw prices halve, halve again and halve yet again. Such that by 1932 prices were back down to 1921 price levels.
In contrast 1990 saw Dow = 2000 price levels, which subsequently doubled, doubled again and then (nearly) doubling yet again up to the 1999 Dow = 14000 highs.
http://ih.fotothing.com/82633.gif
So far we've seen subsequent declines of just a single halving from those 2007 highs.
Most of the rules and controls put in place after the 1930's to 'prevent this sort of thing ever occurring again' have more recently been revoked and stock ownership and excessive use of leverage are common/widespread. So far there have been some considerable similarities.
I'm not saying that we're due for two further halvings yet to occur, but failing to recognise that history might be repeating could be a costly mistake.
Roger - thanks for your response.
Stephen - I'm no expert and, like the title of Roger's post, there's inherent ambiguity of definition when you ask whether "2007 IS 1929." But if I were a betting man, I'd say the answer is, in many ways yes. My reason for that answer is that many people smarter than I think that way, I've read their analysis, and I agree.
That said, will the market plunge 89%? Maybe not. Do I think we have further down to go? I do. I've looked at long term cycles and waves. I've also looked at psychological and emotional factors. Clive makes a very good point about the similarities between the two periods, such as the "roaring 20s" vs. the "irrational exuberance" of the 90's. And Congress even repealed the Glass Steagall Act back in 1999! It's like they were just begging for trouble.
So big picture, my OPINION is that yes, we are in a 1929-1937 scenario. Of course that doesn't mean it will play out the exact same way. We may not have 25% unemployment for instance (although we may). But big picture perspective, I do believe it's history repeating itself.
To repost my own personal 'process' - to address the potential downside risks, I personally allocate around one half of (original) fund value to the style I outlined in
http://randomroger.blogspot.com/2009/02/sunday-morning-coffee_22.html#comments
9:32AM posting. The other half is in a more conventional stock holding style.
Both parts have a tendency towards comparable longer term total returns (when backtested from 1800). The stop-loss style however has tight controls on downside losses. So if stocks do halve, halve again and halve yet again I would anticipate one half of the 'style' pair staying at around original levels whilst the other carried the full downside loss. Resulting in perhaps around 50% of original value level being maintained at the lows.
Again if history repeats, a double up after having endured three halvings in a row typically comes relatively quickly, which from a 50% overall down type level could mean getting back to break-even within an acceptable amount of time.
I'm no expert, nor am I financial qualified etc. - just run my own private account, so this is just my personal view/stance/opinion.
I'm sure there are better ways and would be interested to hear about others investment 'process'.
Hello Roger and all blog participant,
Today it was very interesting the presentation of Chairman Bernake. There were many points that I like to point out, the question about the banking system during the different crisis. He mentioned that to live one is not the same as to study one (Mr. Bernake is the outmost authority of great depression). And the current crisis was not even close to magnitude and the complexity than the past ones. We came very close to a total collapse. This crisis had an effect outside of the USA even into institutions that he could never imagine. He mentioned that he recommends a body to oversee systemic risks that would have a wide authority for gathering data. So we are moving in the right direction to implement legislation to put in place future controls.
A legislator today announces that the uptick rule will be brought back.
As to the city bank profitability an Obama administrator mentioned that the bank has so much of questionable instruments that he does not know if it is solvent. However, all the sudden like magic they are very close to being profitable.
Clive, as to my investment philosophy, I am very young on investment even though I am older than middle age. I do not use any mechanical system. I follow the general market every day. I follow stocks that have a theme. When these stocks are cheep relative to the market then I start taking big position. I might stay for a day up to a week. If the stock does not act the way I anticipate I close the position. If it goes against me I close the position as soon as possible even with a small loss. The rest of the time I am into cash. So the risk is close to nil since I am in cash for most of the days of the year. I may get into a position onece a month perhaps one in a two-month period. I follow a new stock for months or even years. I look at fundamentals but most technical (because the market has a psychological component). Some times the technical tells you more than the fundamentals. Look at City when it was trading for 55 two years ago, I was following CNBC-Europe and there where many questions to panellist about purchasing City in the 40’s for the pension account. This panellist was so positive about such purchase because of the dividends and the strong balance sheet and the brand and so forth and so on. But I did not touch it. I remember around July 15, 2008, Roger was saying that we would have a small rally, Oil was $149 and US Airway that day was $1,45, called CNBC Europe, and the panellist had said that investing in airlines was like “having your Italian lira fly out the planes windows.” So I became gun shy to pull the trigger. However I had traded JetBlue prior to that very successfully. I had become interested in LCC because the moves where more dynamic than jblu. Now I do not put on CNBC too much, only to get the news as to what is happening. I feel that every day there is an opportunity in the markets. But you must understand and believe in that opportunity, for you to take that position. But must be weary that you did not make a mistake, because you could have been too early or that you overlooked at something, so must get out. I do not believe in trading too much, but must be selective. I do not believe in diversification since to follow two positions requires double the time in following a position, and have a limited time during the day. Currently the 30% of the profits that I make from taking these one-day to a week trades; I invest in stocks for the long term. The cash position is up this year 15% the stock position I do not count since it has been acquired with profits, but it is suffering. I do not have a stop-loss order on the stock portfolio since it is a long-term investment. However when the market turns around even in 3 years from now I feel that this portfolio can give me some satisfaction. I have only placed long positions. I have only two loss positions. One I closed after 3 days, the other took longer with a bigger loss because I can only place one order on a stock. But that day I wanted to change the order and had to wait for the next day. I do not place orders directly to the bank in order to have total objectivity. I am handicapped since I can put the order until 11.00AM Eastern Time. Must go.
Best to all,
Jeff from Milan, Italy
Thanks for sharing your process Jeff.
Many moons ago I attended some seminars (the free introductory ones that attempt to get you to sign up for the main (expensive) course) that outlined methods alone the lines that I believe you might use.
They principally advocated identifying breakout conditions with support/resistance based profit targets. Looked great on paper, but when I personally tried to replicate the concept in the forward direction the small losses from stopping out those where the breakout faltered more or less countered the larger gains made where the target profit was achieved.
I ended up spending quite some time evaluating every AFL indicator (and combinations) that I could lay my hands on for AMIBroker and came to the conclusion that the profits achieved were little better (if at all) than that of a more simplistic and less time demanding investment style.
Although part Irish, I don’t seem to have inherited the luck. If anything my stock choices are likely a counter indicator (it’s good to sell what I buy). I can see the attractiveness however for those better skilled (or luckier) than myself.
Thanks again.
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