“For as long as I can remember, veteran businessmen and investors – I among them – have been warning about the dangers of irrational stock speculation and hammering away at the theme that stock certificates are deeds of ownership and not betting slips… The professional investor has no choice but to sit by quietly while the mob has its day, until the enthusiasm or panic of the speculators and non-professionals has been spent. He is not impatient, nor is he even in a very great hurry, for he is an investor, not a gambler or a speculator. The seeds of any bust are inherent in any boom that outstrips the pace of whatever solid factors gave it its impetus in the first place. There are no safeguards that can protect the emotional investor from himself.”
I’ve often noted that even a run-of-the-mill bear market decline wipes out more than half of the preceding bull market advance. I doubt that the present instance will be different. Indeed, cyclical bear market declines that occur in the context of secular bear markets average a market loss of about 39%, wiping out about 80% of the prior bull market advance. We presently estimate a nominal total return for the S&P 500 of just 3.2% annually over the coming decade. It is not pessimism, but optimism – and optimism born of a century of evidence – that we expect stocks to provide more favorable opportunities for investment over the completion of this cycle. It is that carefully-studied optimism that leads us to reject the notion that investors are forced to crawl to the ground and “lock in” low prospective long-term returns, while ignoring severe intermediate-term risks to capital.
I’ll note in passing that the Shiller P/E reached 24 last week (S&P 500 divided by the 10-year average of inflation-adjusted earnings). Secular bear market lows have typically taken the Shiller P/E below 8 before durable secular bull market advances have taken hold. Valuations are a long way off from that, though I would expect at least one or two more complete bull-bear cycles to emerge before the market achieves valuations that would support a durable secular uptrend. There will be plenty of significant opportunities to periodically accept market exposure even if a secular bull market is nowhere in sight.
The perception that investors are “forced” to hold stocks is driven by a growing inattention to risk. But Investors are not simply choosing between a 3.2% prospective 10-year return in stocks versus a zero return on cash. They are also choosing between an exposure to 30-50% interim losses in stocks versus an exposure to zero loss in cash. They aren’t focused on the “risk” aspect of the tradeoff, because they believe that they will somehow be able to exit stocks before the tens of millions of other investors who hold identical expectations.