- The stock markets are entering rarefied territory when it comes to valuations.
- There is usually not much money to be made from new monies invested at these tops.
- We'll look at the returns from previous market tops.
- What is the best strategy, and how do we create dry power out of thin air?
I am going to contradict myself, somewhat. I have no idea where the markets will go as it once again sits near all time highs in price terms.
In this article I examined what happened after markets crested a price top. I wrote that article over one year ago in February of 2013 as the markets approached the top, and I asked:
Is the party over? Is the retail investor arriving at the festivities to find the clean-up crew picking up the empty beer bottles and empty pizza boxes?
We asked Mr. Market.
Well Mr. Market said that when there is a new all time high made, there were basically 6 periods of further long-term gains to be had and 8 periods of modest-to-severe declines. There's no way to know where the markets are going to go after they reach new highs.
And in 2013 we know what happened from the time that I wrote that article.
As I offered over a year ago, I have no idea what the chart will look like 1, 3, or 5 years from now. But I would suggest that there is the likelihood or possibility that there is not much money to be made with monies invested today, or perhaps even with monies that were invested over the last year. Not if we're talking 5, 7, and perhaps 10 year time frames.
As we all know all too well, we entered a long term secular bear market at the beginning of this century.
Any monies invested in January of 2000 in the broad market S&P 500 (NYSEARCA:SPY) would have a total return of -5.3% over 5 years with dividends reinvested.
From 2000 over ten years we would see a -.99% return.
From 2000 to present we have a total return of 63%, or annualized returns of 3.5%. Factor in inflation and moneychimp.com says the return would then be a compound annual growth rate of 1.17% to December of 2013. Cash (CDs) would have beaten the snot out of the stock market from that start date, with zero risk.
Now if we move back one year before the market top, we see that monies invested would still not have made any "real money."
Over 5 years from 1999 a -3.1% total return.
Over 10 years from 1999 a -13.1% total return.
From 1999 to present we have a 101% total return, or a 4.7% annual return. In 2013, and to quote Prince, were we investing "like it's 1999"?
Let's go back to a similar long-term bear market from the late 60s through to 1980.
We'll examine the returns from monies invested in the early period of the secular bear. The asterisk (*) denotes a market top.
5 year (CAGR)
10 year real return
We can see that there were very meager returns near the market tops in 1969 and 1973, basically 3% annual returns from each starting point to the end of the secular bear. I'll opine that the bear ended in 1980.
But there were opportunities to generate some decent returns for those who followed Mr. Buffett's "Be greedy when others are fearful" credo. Monies invested in January of 1975 to 1980 (the approximate end of the bear market) would have delivered a 17.7% annual return. Any monies invested through the year 1970 to 1980 would have delivered annualized returns of 8% to 10%.
Over that extended bear market, an investor who had monies available to reinvest near market bottoms could have likely turned very modest returns into quite sensible average annual returns depending on the size of the bottom buying.
And more importantly and as always, investing on a regular schedule is perhaps all it takes in any environment. Buy every two weeks, buy every month. Here are the annualized returns for each year from 1967 to 1980. The monies were invested at the beginning of each year, to December 31, 1979.
Now certainly inflation ate up all those gains (sorry to rain on the parade) but it does demonstrate how consistency and the reinvestment of those dividends can eke out or boost gains even through a savage bear market.
The current bear market may look cruel on the surface, but it has delivered some moderate returns to investors who have been reinvesting through the bear cycles when the markets have gone on sale.
Here are the annual returns from each year to December of 2013.
Annual Returns to 2013
Now those numbers are certainly affected by the recent and incredible move by the markets in the last two years. Investors would have had to be very patient. Those funds invested in 1999-2001 essentially did nothing for quite a while. Here are funds invested for those years over 5, 7 and ten years.
10 year real return
In hindsight, that was a 3 year investment period that did not pay off over a ten year time span. And perhaps there are times when it should be obvious or probable that there is not much money to be made moving forward over 5-10 year time frames.
The last two years of incredible returns have certainly affected the long term total returns. And that could change in a hurry as we sit at all time highs after one of the best years the S&P 500 has delivered. In fact 2013 was the second best year over the last 40. Those annualized returns to 2013 could be slashed in a hurry. The current bull run is a little long in the tooth; the probability that a correction is on the way is considerable. The question is, are we in a new secular bull market, or is there one more significant correction on the way before we start another secular bull run? We are certainly at a turning point.
Eric Parnell penned a recent article on the 7-year itch for the stock markets. Are markets feeling a little itchy again? Is it scratch time?
And certainly from a stock market valuation standpoint, many will write that the expected returns for stocks from today and over the next decade are in the 1% to 2% range. We are well above historical norms for price-to-earnings ratios. We are moving into rarefied territory.
And here's a wonderful chart from Seeking Alpha author Doug Short, from his site advisorperspectives.com
That is a wonderful chart that has 3 or more articles worth of evaluation. What that chart also reflects is that the markets can remain irrational and exuberant for extended periods. The markets have been in an area of over-valuation for most of the time from the mid 90s. We have not yet had that typical deep correction when it comes to trimming valuations.
The real money is (usually) not made at or near market tops. The generous returns that allow an investor to gain or top the market averages are made in the corrections when the markets go on sale. And in periods when the markets are underperforming over longer periods, there are always opportunities to buy "cheaper" as the chart suggests.
If you are dollar cost averaging and the amount of new investments is significant enough, congratulations, carry on. That is likely the most sure way that you will grab equities when they go on sale, and it's even likely that you will purchase at the bottom.
If you are not investing on a regular schedule and do not have cash available, you might consider managing risk with bonds. Not only will you manage the portfolio volatility and most likely protect the value of your portfolio, you might be able to create some dry powder out of thin air with long term Treasuries (NYSEARCA:TLT).
In this article, you can see how long term Treasuries have been inversely correlated to the markets when we need that inverse relationship the most. That creates the opportunity to rebalance if stocks go down (on sale) and Treasuries go up. And beyond rebalancing you might then place a target switch. That is, say if stocks fall 30% and your TLT is up smartly you might do a full switch and return to your previous allocation.
And as per the last ten years, I think that the 75% stocks to 25% bonds (broad bond portfolio or TLT) will match or outperform the equity markets with much lower risk or volatility. Investors might ask themselves, what is the best risk return proposition moving forward from these levels?
And if you are newer to equity investing (or you now have significant and meaningful monies in equities) and have not been through a market correction, it's certainly gut check time. Remember most money is "lost" due to investors selling out of fear. That is, their portfolio does not match their risk tolerance level.
Happy investing, and be careful out there.
Disclosure: I am long SPY, DIA, VYM. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. Dale Roberts is an investment funds associate at Tangerine Bank (formerly ING Direct). The Tangerine Investment Portfolios offer complete, low-fee index-based portfolios to Canadians. Dale's commentary does not constitute investment advice. The opinions and information should only be factored into an investor's overall opinion forming process