An excerpt from the new book 'The Dick Davis Dividend: Straight Talk on Making Money from 40 Years on Wall Street' - reprinted with permission of the author and publisher:
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The Durability of Major Trends Is Underestimated
A tough part of an investment analyst’s job is forecasting change, especially trying to predict when that change will occur. What makes it difficult is that at any given time, the odds favor a trend in force remaining in force. In its early stages, it’s unclear whether a developing trend will last. But once it takes hold, once it gets its sea legs and gets used to its surroundings, it’s usually reluctant to go away. The more it hangs around, the stronger, the more confident, and the more anchored it becomes. This type of stability is often viewed with skepticism by an investment world that is in constant flux. It’s a world where stocks, groups, and styles continually move into and then out of favor. It’s a world of shifting currents with a myopic focus on the short term. It’s the kind of world that looks mostly for endings, not lastings. And it’s the kind of world that typically forecasts the demise of any trend that perseveres to multiyear status.
The truth is that well - entrenched trends, whether they apply to the overall market, stocks, interest rates, inflation, or the economy, are exceedingly difficult to reverse. They usually last longer and go further than most everybody expects. The stock market went from Dow 769 in 1982 to Dow 11,722 in early 2000, an 18 - year bull market. During that time period, thousands of stocks mirrored the Dow, each one in its own long - lasting bull market. Interest rates on the 10 - year U.S. Treasury bond declined from almost 16 percent in 1981 to 3.07 percent in June 2003.That’s a 22 - year bull market in bonds (as yields go down, bond prices go up). Inflation dropped from 13.5 percent in 1980 to 1.9 percent in 1998. That’s an 18 - year downtrend in inflation. The economic expansion that started in 1991 ended 10 years later in 2001 (after a brief recession, another expansion started in early 2002). The price of gold dropped from $ 870 an ounce in January 1980 to $ 250 in 2001, a 22 - year bear market in gold (it has since recovered to a high of over $ 700).
Perhaps the persistent domination of value, small cap, and real estate investment trust [REIT] stocks is the most impressive example of major trend durability. All three defied a loud and growing consensus of naysayers. Each of the past few years has started with forecasts of “this year large caps will be the place to be.” In the meantime, by mid-2006, small stocks were entering their eighth straight year of outperforming big caps by a wide margin (1975 to 1983 was also an eight - year winning streak for small caps). And by year - end 2006, despite widespread predictions of their demise, value stocks extended their supremacy over growth stocks and REITs surpassed the S&P 500 Index, both for seven straight years. This meant, of course, equally long losing streaks for large caps and growth stocks.The longer the streak, the more numerous and certain are the forecasts that it will end.
Of course, none of these were straight-line trends. There are always corrections or countertrends, some quite long, along the way. But in all of these instances (and the list of examples is far from complete), the primary, underlying trend prevailed. Once grooved in, major trends often show amazing durability. Their staying power is consistently underestimated by Wall Street (which may or may not have something to do with the fact that forecasting change is likely to generate more business than the status quo).
Like everything else in the investment world, there are always exceptions. By definition, a major trend is major because it has achieved a certain maturity, but not all major trends last beyond expectations. What we can say is that the longer it endures, the more likely the principal of the durability of major trends will apply. It’s similar to the reasoning behind projected life expectancy.The 60 - year - old male with a life expectancy of 80, once he turns 80, is expected to live another eight years and then another five after that.
This is Gonna Last
Over the years that I’ve followed established trends in the market, I’ve often said to myself,“ This is gonna last a lot longer.” Sometimes I’m wrong, but more often than not, widespread expectations of the demise of an aging trend prove premature. Part of investing is dealing with extremes. Extended markets typically become more extended, and extended trends in individual stocks tend to do the same. Forecasts of a revival in the lagging large cap growth stocks will, indeed, prove correct. Other poorly performing asset classes and investment styles will also emerge. But that doesn’t erase the fact that over a long period of years poor investment decisions have been made based on false expectations.
I believe an awareness of this concept of major trend durability can be a big help to investors. It can prevent buying and/or selling too soon. Still, it is seldom discussed. Its neglect probably has something to do with the obsession of Wall Street and the financial media on news of the here and now.The short - term focus is so intense and all-pervasive that it blots out what really matters — the long term trend.
One caveat: In terms of the stock market’s overall direction, downtrends typically don’t last as long as uptrends, so the durability principle is less likely to apply. The shorter life of market declines means they have less time to dig in (the great crashes of 1929 – 1932 and 2000 – 2002 both lasted less than three years).A sideways or range bound market, however, can last and last. It took the Dow 17 years, from 1965 to 1982, before it broke out of the 600 to 1,000 range.
Most gurus are forecasting modest single - digit gains in the major indexes on average in the foreseeable future. If they’re right, the durability principle will apply to a sideways, trading - range trend, not a sustained move up or down. But there are always deeply entrenched trends outside the market indexes themselves. They might include asset classes, market sectors, styles, groups, interest rates, inflation, gold, the dollar, and so on. There’s always something going on that’s going to last longer than everyone thinks.
If you can develop the patience and discipline to stay with the major trend, and are not faked out by the false countermoves along the way, the odds favor your being pleased and surprised at just how far it will take you. A quiet but confident awareness of this recurring phenomenon in market history will give you an edge. It will prevent you from disturbing solid positions and help keep you on the right side of the market. And it will make it easier to put into proper perspective the daily onslaught of short term oriented news and opinion.