Valuation-Informed Indexing #365
By Rob Bennett
From January 1, 2000, through December 31, 2016, the annualized real return on stocks was 2.25 percent.
Gates Capital Management's ECF Value Funds have a fantastic track record. The funds (full-name Excess Cash Flow Value Funds), which invest in an event-driven equity and credit strategy, have produced a 12.6% annualised return over the past 26 years. The funds added 7.7% overall in the second half of 2022, outperforming the 3.4% return for Read More
That’s not good. That’s poor performance. 17 years of it.
Investors who don’t adjust their expectations of stock performance to reflect valuations were expecting annual returns of something in the neighborhood of 6.5 percent real during that 17-year time-period. The fact that real-world returns came up so far short of expectations means that those millions of people have less to spend on cars than they would have had their expectations been more realistic. And less to spend on clothing. And less to spend on eating out. And on everything else. Our entire economy takes a big hit when stocks produce such underwhelming results for such an extended period of time.
We all save less too, of course. Most of us think of our paychecks as the source of our savings. But the reality is that a large percentage of our savings is the return we obtain on money we saved from earlier paychecks and invested in stocks. The compounding returns phenomenon really is the eighth wonder of the world for middle-class people seeking a decent retirement. When stock returns dry up, annual additions to accumulated wealth slow down dramatically for most of us. When stocks perform poorly for 17 years running, we all fall behind on our efforts to achieve our most important long-term financial goals.
I think it would be fair to describe the 17 years of poor performance of stocks as a “crisis” for most middle-class workers. But I don’t recall ever hearing anyone else make this point. Quite to the contrary, most statements about the performance of the stock market assert that stocks have been doing well, that the market has been setting record highs.
Can both things be true? Can the market be performing poorly and also setting record highs?
There is a sense in which both things can be true. Stock prices can hit new highs without there being any real growth whatsoever through the force of inflation. And of course even gains of 2.25 percent real are gains that can push stock prices to record highs. They just aren’t gains sufficient for most of us to retire according to the schedule by which we had hoped to retire. Today’s stock market is setting technical records that are not worthy of celebration.
Robert Shiller in his book Irrational Exuberance explains why it is that we hear so little about the dismal long-term performance of our stock market. The fix is in. Investors want to believe that their investments are doing well. So they filter out bad reports of the market’s performance and draw encouragement from positive reports. Investment advisors want to assure their customers that they are doing a good job so they too focus on the breaking of records and fail to mention how far short the market’s performance has been from what was expected for the next 17 years when we were at the beginning of those 17 years. The owners of web sites know that people like to click on articles offering a happy take on how stocks are doing. So they play the game as well.
Does it matter? Perhaps it is best that we look on the sunny side and not darken our thinking with consideration of 17 years of sub-par stock performance.
I think it matters. I think that we need to consider why it is that stocks have been producing such poor returns for such an extended period of time. These long stretches of poor stock performance don’t pop up randomly. We always see them in the wake of time-periods in which stock price gains far exceed the average long-term return of 6.5 percent real. Those sorts of gains are produced by investor emotion, not economic realities. The bull market is a phenomenon in which investors collectively borrow gains from the future to enjoy in the present. We are living today through the future that we borrowed from to enjoy the swinging party of the late 1990s. It’s only be coming to recognize how bad recent returns have been that we can appreciate how much we hurt ourselves when we push stock valuations to unsustainable levels.
We all should be talking about how bad stock returns have been for over 17 years now. We sure would be talking about it if prices had continued upward at the pace at which they were rising in the 1990s. We fool ourselves into thinking that stocks are a more appealing asset class than they are when we direct lots of mental energy to the celebration of times of rapidly rising prices and then look the other way during extended times of only slowly rising prices. We need to let in both sides of the story to develop a full understanding of how the stock market really works.
Stock investors are hurting today. They don’t know it and so they rarely complain about it. But they are hurting all the same. And since the stock market as become an important part of every middle-class worker’s plan to achieve a decent old-age retirement, that’s a reality with public policy implications for all of us.
Rob’s bio is here.