The Law of gravity has not been repealed. What has risen will, at some point, decline. But, when? Hundreds of people are paid millions of dollars to predict the unpredictable. Yet, the best advice about the direction of the market over the short term I have ever read was given by J.P. Morgan. The story may be apocryphal, but it was re-told by Benjamin Graham in The Intelligent Investor (1949); it still resonates. Asked by his lift boy, in 1901, what will the stock market do? He replied, “it will fluctuate.”
The past year has seen establishment-types in Washington, mainstream media and coastal elites trying to undo last year’s election. Has the market’s positive performance deepened their denial and made more passionate their hysteria? Would they have been so relentless had stocks done as Paul Krugman (economist and New York Times columnist) predicted when news of Trump’s election was clear? Krugman wrote as stock futures plunged early before trading began on Wednesday, the 9th of November. As to when they would recover, he opined: “a first-pass answer is never.” The DJIA rose 257 points that day.
The performance of U.S. equity markets since the election of Donald Trump has been remarkable. He came after a President who entered office following the worst financial crisis since the 1930s. Stocks were at five-year lows. Mr. Obama’s two terms saw the market (DJIA) rise 151%; he left office with an approval rating in the mid 50% range. In contrast, Mr. Trump was elected with stocks near all-time highs, and he has the lowest approval numbers in memory. However, those ratings run counter to optimism seen in polls like the IDB/TIPP Poll: Economic Optimism Index – a mixture of consumers, workers and investors. Over the first sixteen years of this century, the Index averaged 49.3, or slightly negative. Today, it stands at 53.6. During the last year of Mr. Obama’s Presidency, the number was under 48.
Benjamin Graham, considered the father of value investing, explained his concept of investing this way: “In the short term, it is like a voting machine – tallying up which firms are popular and unpopular. But in the long run, it is like a weighing machine – assessing the substance of a company.” Is a year a long enough period to measure Mr. Trump? Is the market reflecting his popularity, or is it weighing what he has accomplished, in restoring cost-benefit analysis and undoing restrictive regulations in federal agencies like the EPA, FDA, FCC, Transportation and the Department of Education? Is it measuring Betsy Devos’s focus on making public school more competitive through vouchers and Charter schools? Is it weighing Mr. Trump’s appointment of originalists as judges, ones more predictable, as they are aligned with the Constitution and less governed by politics or relativism? Does it see an end to authoritarianism at the CFPB?
I don’t pretend to know why markets have done what they have. And I know they will correct, but when and by how much? So, what should investors do? There are no simple answers. The needs of each is individual. The future is like peering through a windshield in driving rain. Clarity is confined to the past.
But, in my experience, market timing is only accurate in retrospect. What I do know is that over the long term – two, three or four decades – stocks have risen. They should continue to do so. If one had bought stocks on September 3, 1929, the day that year the DJIA peaked, one’s compounded annual return, through today, would still have been 4.8%, even though stocks did not exceed those 1929 prices until 1954.[1] If you had reinvested dividends your total compounded annual return would have exceeded 6%. On my birthdate, January 31, 1941, the DJIA was roughly one third of what it had been twelve years earlier. If my grandparents had given me a $1000 as a birth gift, and if I had been smart enough to leave it invested, it would be now worth $187,000, or a 7.01% CAGR. Over the 48 years I spent on Wall Street annual returns compounded at 6.3%, despite stocks being lower fifteen years after I got into the business.
Mr. Obama became President at a fortuitous time. During his eight years in office, the DJIA compounded at an annual rate of 12.1%. But, had you bought stocks on the dawn of the new millennium, on January 3, 2000, your compounded return would have been only 3.9%. That modest performance reflects the bear market that began in March 2000 and ended in March 2003; and the one that began in October 2007 and ended in May 2009. If one goes back 100 years, stocks, as measured by the DJIA, have compounded at 5.9% – a reasonable assumption for future prospects, considering what the last century saw: a world-wide depression, two world wars and numerous smaller ones, a cold war that lasted forty-five years, the deaths in office of three presidents (one by assassination), a bout of inflation that sent Treasuries to 20% yields, the first attack on American soil since the war of 1812, and a credit crisis that nearly sent financial markets into a tail spin. But it was also a period that highlighted American creative genius, that saw the Country land a man on the moon, and which witnessed revolutions in farming, manufacturing, transportation, merchandising, electronics, computing and communications.
There have been structural changes in markets. Among them has been the shrinking of the number of publically traded stocks, and the concomitant increase in value of those that survived. According to the Carlyle Group, there are 3671 companies listed on U.S. stock exchanges today. Twenty years ago, there were about 7300, yet the value of publically traded stocks today – about $27 trillion – is double the value of all publically traded stocks in 1997. What happened? Private equity allows start-ups to wait longer to go public. Mergers and bankruptcies caused the disappearance of many micro and small-cap stocks. Also, passive strategies have limited the number of shares available for trading. Since the millennium, about $1.7 trillion has been invested in index funds, ETFs and other similar strategies, while funds actively managed have seen about $1.4 trillion in outflows. Equity derivatives have affected valuations, altering the nature of risk. And, over the past eight years, the Fed purchased over $4 trillion in government and agency debt. That has ended. The yield on 30-day Treasury Bills has risen from 0.26% on September 30, 2016 to 1.29% now. Over the same time, the spread between Investment Grade Corporates and the 10-Year Treasury has narrowed from 191 basis points to 137 basis points, implying a willingness to assume more risk.
In response to Mr. Buffett’s quote in the rubric at the top of this essay, I suspect people are neither greedy nor fearful. They are somewhere in between. But, keep in mind, investing is for tortoises, not hares. Avoid being cute or believing every seer. Think long term and maintain perspective.
The only addition I would add to the wisdom of J.P. Morgan quoted at the start of this essay is that over the long-term stocks rise; though returns can be negative for a decade or more. The caveat: our democracy, entrepreneurship and capitalism survive. Warren Buffett recently predicted the DJIA will hit 1,000,000 in the next hundred years. One’s first reaction is that the Wizard of Omaha is losing it; but 1,000,000 on the DJIA from the current level implies compounded annual returns of 3.7%, easily doable, as long as our democracy stays strong. My guess is that my great grandchildren will see that happen.
