Ariel Investments commentary for the month ended September 30, 2016.
Equities had strong returns in the third quarter of 2016, and predictably the urge to sell U.S. stocks is rising. One group advances the “take some chips off the table” strategy. After small caps of the Russell 2000 Index leapt +9.05% and the S&P 500 Index’s large caps advanced +3.85% this quarter, they wish to capture gains by going to cash. Others make a valuation argument: the S&P 500 Index has a price/earnings (P/E) ratio approaching 25x, above the long-term average of 16x. From this perspective, equities are expensive and are likely to revert toward the mean. These views are common: more than half of professional investors expect either a bear market or a correction.
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Yet whatever the rationale, selling stocks due to returns or valuation boils down to market timing. We think the market is too efficient to time with any consistency. So we advise owning for the long term, because markets tend to rise over time and stocks tend to outperform other asset classes. As you know, Ariel Investments has a very long-term perspective: our flagship Ariel Fund will celebrate its 30th anniversary on November 6th, 2016. Below are the returns of cash, bonds and stocks over various standard time periods going out to 30 years.
One pattern is clear: positive returns for the major asset classes over all the periods above. True, sometimes shorter periods will show negative returns, but very long periods rarely do. Indeed, going back to 1926, there are 244 30-year periods that conclude at quarter end. In those nearly 250 periods, all five asset classes above had positive returns every time. Surely bonds and stocks retreat from time to time, but when you held for three decades, you overcame those dips.
Also note that equities had the best returns in seven out of eight time periods. Obviously, the exception is where bonds top stocks by half a percentage point over the last ten years. As you know, that segment contains the Great Financial Crisis, when stocks fell more than -50%. (And yet stocks still managed to gain +7% over the decade!) Turning to the other stretches, small-cap stocks have the top returns in five periods, including the 30-year. Large caps are tops in the other two periods.
Ultimately the impulse to sell stocks stems from the desire to avoid losses. We think it is very difficult to know when a downturn will start or end. So, to our minds, the better game plan is to be patient and hold for the very long term. As above, that has been a dependable recipe for gains.
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