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moneysense.ca, 3/02/09
Good returns are more likely to follow bad returns
Current issue:
Investors are not just discouraged by poor stock market returns over the past 10 years. They are also extrapolating the poor returns in the past and wondering if future returns will be dismal as well. This “recency bias” — overemphasizing recent data while ignoring older data — is hardly new. In the late 1990s, most investors thought that the future would look like the recent past: double-digit returns far into the future.
Longer-term data shows that stock market returns have a tendency to revert to the mean, which is just a fancy way of saying that relatively poor performance is likely to be followed by relatively good performance. This isn’t a sure thing, of course — just ask Japanese investors who have endured more than 20 years to poor returns. Still, the S&P 500 has returned about 9% over the long-term and -2.5% over the past 10 years. Odds are that the former is a better indicator of expected returns over the next 10 years than the latter.
moneysense.ca, 3/02/09
The finding that stock prices tend to revert to the mean lends credence to the theory that stocks have an intrinsic value separate from the actual trading price that is less volatile than trading prices.
Couldn’t agree more – if you were buying stocks a year ago then clearly the prices are better now – so why stop buying?
I don’t how many times I’ve read of people who are changing their retirement contributions to buy cash (or money market) instead of equities. Dumb.
The Nikkei example really does concern me. I think 20 years of bad returns would really test anyone’s faith in the lazy portfolio approach.
Tyler – the Nikkei only covers one country. I think that is a good reason to diversify over different countries.
True … but not until we hit the bottom … which maybe sometime in the future.
I couldn’t agree more! Historical data shows that in the 10 years following each of the last three market down turns Canadian indexes showed a rebound of approximately 16%. While most analysts are hesitant to say there will be a 16% rebound this time, most are willing to say a nine percent rebound is reasonable to expect.
The stock market doesn’t remember what price point that you bought your stock. How do you evaluate whether a stock is “cheap”? If you measure it according to forward earnings, then you’ll find earnings are down. If you measure it according to revenues, then you’ll find revenues are down. Just because a company USED to make X earnings doesn’t mean that it will continue to make X earnings. Ask someone who has been recently laid off auto worker whether they will earn as much this year or next as they did before they got laid off? Maybe, but I wouldn’t bet money on it.
If this is the start of a major worldwide depression, then you’ll find that any stocks you buy now will be “dead money” for a very long time. Especially if all of the protectionist rhetoric from our trading partners continue to ramp up. Canada is an export economy – we depend upon our exports for our economy. If our trading partners refuse to import our products, we’re all totally screwed regardless of what industry you’re in… OK, except for Government, civil servants will always have a job…
What worries me about Japan is the following. The Japanese model of growth hit a wall for stock market investors in 1990. However, other Asian countries, such as China, seem to be using a similar growth model. Will other countries using the same growth model hit this wall? Does that mean one should be cautious about stock market investing in those countries? Comments, from those who know more about economics in East Asia, are most welcome.
tyler: The Japanese experience is worrying but I wonder if it is as bad as nominal returns make it seem to be. Since, Japan has been experiencing deflation, perhaps the real returns weren’t as bad? It is worth checking out. I have requested Triumph of the Optimists from the library and it includes real return data for Japan. I’ll post what I find out.
I recall that Japan had only a 3% annual return per year over the past century ( can’t recall whether it was a real or nominal return however).
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Japanese stock markets had another 20-30 year period where stock prices couldn’t exceed their end of wwI highs untill after WWII..
Maybe that’s why Japan invaded China in 1931 ( a little bit of history, what else do you need
anyone downloaded Demographic Winter from bittorrent..
scares the heck out me..
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