Why is it so difficult to stay fully invested in stocks in a disciplined, rational manner, without participating in manias or selling at the bottom? Because, even during bull markets, lengthy periods of stable, normal economic growth are actually extremely rare. “Unthinkable” events occur on a regular basis. Consider stock market history over the past four decades:
- 1973: Commodity prices soar and oil prices quadruple as OPEC embargoes oil during the Yom Kippur War. Prices of the high-PE “nifty fifty” growth stocks collapse.
- 1980: CPI inflation is 13.5% and interest rate soar to 20%. Economists believe inflation will remain elevated for years. Boom times in Texas.
- 1983: Instead inflation falls to 4% by 1983. With commodity prices and corporate pricing power collapsing, the profitability of many big U.S. industrial firms implodes. Mexico and other “LDC’s” effectively go bankrupt, threatening New York Banks. By 1990 all the major banks in Texas disappear.
- 1987: Stock prices fall 22% in a day and more than 30% over just two months.
- 1990: The real estate and LBO boom of the 1980s ends as Saddam Hussein invades Kuwait in the summer 1990. The ensuing recession nearly precipitates a financial crisis.
- 1998: The Asian financial crisis causes a global financial panic that destroys one of the biggest hedge funds, Long Term Capital Management. Stocks plunge and the junk bond market temporarily seizes up.
- 2000: A five-year stock market boom culminates in a tech bubble that collapses in 2000-2001; stocks don’t bottom out until October 2002. (The tech crash was even more costly than the 1929 crash because many dot.com’s and other widely held issues effectively went to zero, including Enron, Worldcomm, Lucent, Nortel and Sun Microsystems. The most popular stocks in the 1920s, such as RCA, GM, Chrysler, GE, and Allied Chemical, lived to fight another day.)
- 2001: Al Qaeda destroys the World Trade Center and attacks the Pentagon, starting a protracted global “War on Terror.”
- 2008: A housing bubble, promoted by Democrats and Republicans alike, leads to a financial crisis that nearly destroys the global banking system in 2008-2009.
- 2009: Europe’s financial system is crippled by a protracted crisis caused by European socialism (too much government, not enough growth), a recession that shatters housing bubbles in certain countries, and a dysfunctional currency system.
That is ten crises in forty years, or one every four years. No wonder it’s hard to hang on to stocks. But good businesses managed to prosper nonetheless; the S&P 500 rose at a 6.3% pace from year-end 1972 to year-end 2011, the average dividend yield was 3.0%. Here are the 40-year stock price CAGRs of a few successful companies: McDonald’s 10.0%, Caterpillar 7.2%, Wal-Mart 20.2%, Coca-Cola 8.4%, GE 7.1%, 3M 5.5%. The 20-year stock price CAGR was 20.5% for Starbucks, 9.5% for Intel, 12.2% for Microsoft, and 11.9% for Nike. The total returns of these stocks were even higher, taking dividends into account. Of course, not all companies are as successful as these, which is why you should keep your winners and sell your losers.
The “Unthinkable is Normal” syndrome underscores why equity investors need a safe cash cushion, for both practical and psychological reasons. In a perceptive article on the history of stock market returns, Ben Inker of GMO points out that one reason why stocks offer investors an attractive 5.9% real long-term return is that stocks tend to collapse at the most inopportune times – during panics, wars, and recessions, when investors most need the money. Which is why buying stocks on margin is dangerous and unwise.
Copyright Thomas Doerflinger 2012. All Rights Reserved.
