Valuation-Informed Indexing #378
By Rob Bennett
I was happy to come across an article the other day that makes a point that I believe has been very much under-reported. The article is by Mark Hulbert and is titled The Shocking Truth About Stock Returns in This Century. Hulbert reports that: “the S&P 500 after inflation has produced just a 0.9 percent annualized price-only return since its March 24, 2000 top.
Lee Ainslie's Maverick Capital had a difficult third quarter, although many hedge funds did. The quarter ended with the S&P 500's worst month since the beginning of the COVID pandemic. Q3 2021 hedge fund letters, conferences and more Maverick fund returns Maverick USA was down 11.6% for the third quarter, bringing its year-to-date return to Read More
I don’t think it is fair to cite the price-only return. Stocks pay dividends. So dividends should be included in assessments of how well the stock market has been performing. Count dividends and the real return so far for this Century is 2.9 percent. That number is not quite so shocking. But it is certainly not good. As Hulbert observes, most investors would guess that stocks have been doing much better for the past 18 years. Why the confusion? How is it that so many of us have been so misled about the long-term performance of the asset class on which our hopes for our financial futures are riding?
Stock performance is a big deal. When millions of people experience sub-par stock returns for many years running, they spend less on all consumer goods and services. The effect on the economy is substantial. But Hulbert is right — most investors are not even aware that stocks have been doing this poorly for this long. People notice when automobile manufacturers are no longer offer strong value propositions, or when companies producing smart phones are no longer getting the job done. But poor stock performance goes unnoted. Why?
The biggest problem is that there is a pro-stock bias that influences all mainstream commentary on this asset class. If you asked the announcers for the Mets baseball team how good the team is, you would not expect to get a realistic assessment. But investors ask people who sell stocks for a living whether stocks are a good investment class or not. It is hard to find a good source of information on investing that is not compromised by a pro-stock bias.
The other big factor is that investors themselves are biased. Most of us have our retirements riding on the future good performance of the stock market. So we very much want to believe that nothing is going to come along to jeopardize that good performance. The biggest reason why much pro-stock bias remains unexposed is that the market for the other side of the story is so limited.
Hulbert mentions another factor. He points out that, while stock prices have generally been rising for most of the new Century, there was a price drop of 49 percent from 2000 through 2002 and a price drop of 57 percent from 2007 through 2009. Prices tend to rise gradually over long periods of time and then fall sharply over short periods of time. The lesson that our minds absorb is that prices head upward a lot more often than they fall. But a few sharp price drops can counter many years of gradually climbing prices.
I believe that there is an even more pervasive problem of perception that is at the root of all these others. We believe that price increases are always a good thing. I don’t think that’s so. I believe that Shiller’s “revolutionary” (his word) 1981 finding that valuations affect long-term returns discredits that idea.
Hulbert asks: “What can we conclude from these depressing statistics?” This fellow is asking troubling questions about stocks. He is saying that the truth about returns for the past 18 years is “shocking.” So as a general rule he could hardly be accused of a pro-stock bias. But I think that that word “depressing” is revealing of a mindset that has not overcome the thinking about how the stock market works that Shiller challenged with his Nobel-prize-winning research.
If price changes are caused by economic developments, as the Buy-and-Holders believe, then all price increases are good because they signal positive economic development. In that event,18 years of subpar returns could indeed be fairly characterised as “depressing.” But Shiller showed that it is investor emotion, not economic developments, that drive stock price changes. The message of Shiller’s research is that stock prices are often wrong; that is, stock prices often do not reflect the realities. Investors would be better off if they did. So it is not ptice movement in an upper direction that is a good, it is movement in the direction of fair-value pricing that is a good.
For those of us who believe that Shiller really did launch a revolution in our understanding of how stock investing works, price jumps are a positive when stocks are underpriced and a negative when stocks are overpriced. Stocks have been overpriced for nearly the entire time-period from 2000 forward. So the low returns we have seen for the first 18 years of the new century are a positive. Higher returns would have made the overvaluation problem worse. We are fortunate that the real annual return has been only 2.9 percent. There’s nothing even a tiny bit depressing about this news.
Think where we would be if we had been “enjoying” the average long-term return of 6.5 percent real all these years. Stocks would today be far more overpriced than they are. Stocks are today prices at two times fair value; we will need to endure horrible economic and social and political consequences just to go through the price crashing that it will take to get prices back to fair-value levels. It would be a nightmare scenario for stocks to be priced even higher, for prices to not have been coming in at levels so much less than normal for so many years now.
We need to stop thinking of stock price increases as a good thing. When we do, it will become a lot easier to keep price increases in check. It is our inclination to think of all price increases as a good thing (and of modest price increases as “depressing”) that makes it hard for us to appreciate the long-term damage we do to ourselves when we permit prices to rise as high as they did in the years prior to the beginning of the new century.
Rob’s bio is here.