For those of you who may have followed my advice in the past and loaded up on commodity based investments in energy, gold and commodity producers around the world, the ride sure has gotten rough lately, hasnâ€™t it? One thing we need to remember at times like this is that the strongest bulls offer the roughest rides, but also the highest scores.
The best analogy I can think of to illustrate what weâ€™re going through is by offering appropriate visual aids. The best one I could think of to help your understanding of my thinking is professional bull riding. On the face of it, this should be getting obvious already.
But if you ever watch any bull riding on ESPN, you become interested in how the scoring is arrived at for each rider. Much of the score for the rider who manages to hang on for a full eight seconds has to do with the difficulty of the bull being ridden, or in bull-rider terminology, â€œthe bull beinâ€™ rode.â€
A lackluster bull can more easily be ridden by most, but the meanest, most â€˜orneryâ€™ bulls will throw off even the best riders most of the time. Managing to hang on for eight seconds garners appropriately high scores for the difficulty involved.
Each bull is scored based on past performances. In the latest rankings, the bull named Smokinâ€™ Joe is near the top, having yet to be successfully ridden. Big Bucks, Walk This Way and Dr. Proctor are the three bulls with similarly impressive buck-off rates, all at 100%.
Each rider draws the bull for his next ride by a drawing method. They donâ€™t get to choose their next ride. So the rider who gets assigned to ride one of those four least rideable bulls can look forward to the roughest ride of his year and the potential for physical injury, but also the potential for a very high score if he manages to hang on. Are you starting to see where Iâ€™m going with this one?
As Iâ€™ve noted in this space before, the search for the truly successful long term stock markets investors meets with almost astounding difficulty too. Where are the great stock market investors of our time? How many people do you know who credit the stock market with having generated their wealth?
And this seems so odd, doesnâ€™t it, with the domestic stock markets at much higher levels than they were at 20, 30 or 50 years ago? With all those wonderful bull markets in the history books of the markets, you would think that some would have managed to hang on for the full ride.
A recent example of how hard it is for most to ride the marketâ€™s bull cycles is the wonderful, secular bull market in stocks from 1982 to early 2000. The S&P 500 rose from about 120 at the start of the bull run to over 1,500 in early 2000. This wonderful run, featuring solid double digit average annual returns are the stuff of investorsâ€™ dreams. You only need one, and I repeat, one rally like this in your investing years to achieve what so few seem to have.
So what went wrong? The Dalbar studies Iâ€™ve told you about in the space before shows that the average stock market investor during that secular rally got a little over a 5% average annual return and would have done better in bonds. So during the best of times, investors fall off the bull early and often. And anyone looking at a chart for that bull market cycle must be looking at something that should have been an easy thing to ride along with.
Hereâ€™s where I think the problem lies in all of this, and how those of you involved in my favorite bull markets can see happening in real time. In early 1982, what in hindsight of course, turned out to be a truly glorious time to load up on stocks, the market had endured one of those secular bear markets, the one from 1964 to 1982 when the major averages like the Dow and the S&P 500 went nowhere in nominal terms, and got crushed in real terms after inflation was factored in.
The S&P 500 topped out in 1964 at 86 and saw its 1982 low of just over 102. The Dow hit its 1963 high of 767, a level almost hit again in the summer of 1982. At a time like that, who wanted to mess with risky assets like stocks? You have to admit, if you were looking at stocks in early 1982, you would have been skeptical too!
So how long would the stock market have to rally before the crowd started to think about stocks as winners again? After all, secular bear markets feature rallies to the upside, all of which fail. The bear market in the Japanese Nikkei average saw three rallies where that index rose by 50% or more during the time period when that index was falling about 80% from its 1989 peak to its 2003 bottom.
So maybe it took two or three years before investors began to look upon the stock market as being a viable investment alternative again. So maybe by 1985, the crowd gets excited and plows back into stocks. Then almost on cue, just as investors started looking forward to seeing their monthly statements again, the stock market crashed in 1987, with the Dow falling 40% in about two weeks.
Imagine how many riders got right thrown off that bull! But then the markets rebounded and where back at their pre-crash highs just a few months later. So maybe investors got their courage back up for another ride on the bull, only to get so close to staying on for the full ride when the recession of 1990 began and the cyclical bear market hit during the summer of that year, with the S&P dropping almost 20%.
Imagine the frustration! While itâ€™s easy enough for us to look at the historical charts for this period, it was an altogether different, and more harrowing experience to live through it and see your life savings getting beaten up like that. Imagine the difficulty of staying on what turned out to be a rather friendly bull.
Of course, as we know now, the markets rebounded again in very short order and investors spooked out during the bear cycle may well have been encouraged back on the bullâ€™s back, albeit after missing the return trip higher from the recent low. Do you see how damaging getting in and out based on emotion can be?
Now about the time when investors had plowed back into the stock market and were starting to think they finally got lucky and were making a profit came the flat market in 1997 that featured another bear beating when the S&P dropped about 14% in a few days in October of that year. How frustrating that must have been!
But now being urged to stay in the markets by their brokers, no doubt, after seeing how every other time theyâ€™d been thrown off the bullâ€™s back over the past 15 years it took mere weeks for the markets to rebound, the chastened investor may well have stayed put during that â€˜97 bear cycle, only to endure another beating in the summer of â€˜98 when the S&P dropped from almost 1,200 in July to a low of about 930 in October.
How many would have gotten into and out of stocks several times, getting out when things looked bleakest, then back in during heady revivals in stocks, then repeating the cycles? Apparently, many, given the Dalbar studies of that secular bull market and the dismal returns earned by the average investor.
And with the S&P riding from just over 100 in 1982 to just over 1,500 in early 2000, imagine what your initial $100,000 investment would have grown to with re-invested dividends added along the way! And most investors got only a fraction of that amount. It seems that most investors invariably seem to draw the meanest bulls to ride at the start of great long term rallies, doesnâ€™t it?
Maybe thatâ€™s the excuse anyway. And some of you can get the full feeling now as to how investors can get spooked out of great long term rallies at the worst times to do so. Those of you who are loaded up with concentrated positions in gold, energy and emerging markets as I am can understand how easily a rider can be thrown off the bullâ€™s back.
Itâ€™s not easy to watch oil drop in price from $77 down to $63 where it is now, or to see gold drop from $740 an ounce down to the current $580. Those of you following the Indian stock market surely saw drops that were unnerving. But for the rider who can stay on that bull, the highest scores are waiting. I didnâ€™t say it was easy to do as some of you no doubt can attest to. And since few if any of you have taken the concentrated positions in those sectors as I have, I feel your pain!
But we all know so few people who made their fortunes in stocks since so few seem to have gone about things with a sound strategy. Let me share the wisdom of two legends in the markets who have done rather nicely over long time periods. Charlie Munger and Seth Glickenhaus.
The former is of course the partner of Warren Buffett, and their track record is well known. The latter was featured in an interview in Barrons in the September 11th issue. His managed fund has beaten the S&P 500 by about 4% per year on average since 1961. Both of them share my disdain for modern portfolio theory, asset allocation and diversification.
According to Mr. Munger, there is little reason to adhere to Wall Streetâ€™s collective wisdom on how to invest. He believes that academiaâ€™s emphasis on diversification as a way of controlling volatility is a waste of time. Most superior investment records have been achieved by ignoring diversification. Munger says that the best advice is to â€œmake a small number of good decisions and stay with them.â€
According to Mr. Glickenhaus, â€œthe greatest error made on Wall Street is diversification… There are risks, unquestionably, but if you do your research and take valuations very seriously and look at the financial statements and buy stocks selling at low multiples, have debt ratios that are not excessive, good growth potential and good profit margins, youâ€™ll be on pretty solid ground.â€
In hindsight, the best times to buy stocks was when they were least loved and prices were low based on measures like P/E ratios, as in 1982. Volatility is normal, but when fundamentals remain in place, getting bucked off glorious bull markets can be devastating.
As in energy and gold markets, those rallies are years old and some selling is to be expected. But the fundamentals of those asset classes look even stronger now. The same can be said of those emerging markets where fiscal policies and organic economic growth far surpass what is seen in the U.S. How fortunate for us to have found those wonderful bulls to ride!
Can you hang on for the full eight seconds, metaphorically speaking, or the full 15 to 18 years, as secular bull markets tend to last? Smokinâ€™ Joe will be ridden some day, and the rider who hangs on will get a very high score indeed.
Have a great week, Bob
Bob Wood ChFC, CLU Yusuf Kadiwala. Registered Investment Advisors, KMA, Inc., firstname.lastname@example.org.