Sorry, Investor — Bad News

The stairs up… and the elevator down.

Here you have the stock market’s general rate of travel — depending upon the stock market’s direction of travel.

The stock market is lately making excellent speed… downward. And over the past 12 months?

Let us assume you own a broad market index fund. You have spent the past year upon the hamster wheel, running and running in place.

Both the Dow Jones Industrial Average and the S&P 500 trade today where they traded last spring.

The Nasdaq Composite, meantime, has receded to November 2020 levels.

Can you afford to spend an entire year running in place? Will it knock your retirement off schedule?

These are the questions we tackle today.

The market always makes its losses good, says Wall Street. History demonstrates — amply — that stocks always increase in the long run.

Thus a recent investor advisory from a large Wall Street concern argues that:

Despite the tumble to begin this year, investors should not panic. Over the long-term course of the markets, investors who have remained patient have been rewarded. Since 1900, the average return to investors has been almost 10% annually… our advice is to remain invested, avoid making drastic movements in your portfolio and ignore the volatility.

There is much justice here. And stocks for the long run is capital advice, a dividend-yielding stratagem.

The white magic of compounding interest will build and build. One day it will yield you a gorgeous pile of money.

“If it was only that simple,” retorts Mr. Lance Roberts of Real Investment Advice.

Roberts contends the Wall Street men omit critical details from their tale. That is, they neglect to inform you how one locust year can throw the compounding strategy into discombobulation. For example:

While the average rate of return may have been 10% over the long term, the markets do not deliver 10% every year. Let’s assume an investor wants to compound their returns by 10% a year over five years. We can do some basic math…

After three straight years of 10% returns, a drawdown of just 10% cuts the average annual compound growth rate by 50%. Furthermore, it then requires a 30% return to regain the average rate of return required.

There is a significant difference between AVERAGE and ACTUAL returns. The impact of losses destroys the annualized “compounding” effect of money.

That is, a mere 10% loss in year three guts the annual compound rate by half — half!

Only a subsequent 30% bonanza can place you back upon the track. How likely is a 30% bonanza?

Not especially, we hazard.

Wall Street men yell about how the Great Financial Crisis soon yielded to one of the loveliest bull markets ever. This bull market made good all prior losses — and plenty more into the bargain.

They do not inform you — Mr. Roberts does — that investors required nearly seven years to claw back even… on an “inflation-adjusted basis.”

Please understand: Roberts does not dismiss the compounding theory. Yet he insists it reduces to timing.

Timing is critical if you wish to realize the wonders of compounding annual interest:

While many suggest the “buy and hold” investing will work over the long term, for most, that period is roughly 15–20 years until retirement. Here is the problem. There are periods in history where returns over 10-year periods were negative…

Yes, “buy and hold” investing will work, but it depends on WHEN you start your investing journey.

And by many accounts, the compounding strategy will turn up snake eyes over the next several years. Why?

Because of very, very poor timing.

Stock market valuations presently float at historic heights — even with the latest pulling back.

And when stock valuations are excessive… you can expect hard sledding in the coming years. Your compounding strategy is in grave peril. Roberts:

The return has everything [to do] with valuations and whether multiples are expanding or contracting… real rates of return rise when valuations expand from low to high levels. But real rates of return fall sharply when valuations have historically exceeded 23X trailing earnings and revert to their long-term mean.

Yes, “buy and hold” investing will work, but it depends on WHEN you start your investing journey. At 35X CAPE, such suggests that returns over the next 10–20 years could be disappointing.

Are you prepared for a two-decade stock market malaise?

It is a grim projection. Yet as we argue often, time equalizes as nothing else.

Scales balance, that which goes up comes down, that which goes down comes up…

The mighty fall, mountains crumble, the meek inherit the Earth…

And the stock market ultimately “regresses to the mean.”

The mills of the gods may grind slowly, as Greek philosopher Sextus Empiricus noted.

But as he warned… They grind exceedingly fine.


Brian Maher

Brian Maher
Managing Editor, The Daily Reckoning

The Daily Reckoning