U.S. Equities: Past Returns Not Necessarily Indicative of Future Performance

I'm about to present some ideas about investing in stocks that will be important for the future. They might even be a little controversial. This advice will be useful, especially if you are new to investing in stocks. If you are in for the long-term there are two big ideas I want you to get from this article. First, the future cannot be predicted by the past. Second, Don't let emotions get the best of your investing.

After the Industrial Revolution the U.S. economy began an upward surge that would carry on into the 20th century. As a result, companies and their stocks did very well. Everyone knows the concept, "Investing in U.S. stocks is a guaranteed 9% return a year when you buy and hold." "Just look at the past." This saying gets drummed up even more when there is a strong bull market like we had in the late 90s. You hear it more because it benefits financial institutions to get as many people as possible to give them business and commissions.

This seemingly low risk return gets repeated in decades of big stock market gains and forgotten when things slow down. In the 1920s huge gains came easily to financial institutions and many inexperienced investors. Alternatively, some people that grew up during the depression or bad decades for the market think investing in stocks is no different than gambling. If you buy this "the future will repeat" idea you get the notion of easy 8,9,10% returns which varies around that range depending on how far you average the market indexes returns.

The problem with this idea for one is it assumes bad recession years will be redeemed with strong bull markets and this will happen before you retire. Secondly, it takes a hundred years of data and makes it seem like you can expect the same returns in a small slice of time. From 1965 until 1983 the Dow Jones Industrial Average was flat. The index was at 1,000 beginning in 1965 and was at 1,000 in 1983. If you had bought the market and held instead of "timing" it there was a big opportunity cost.

Don't expect buy and hold to work over any time period. Instead of trying to time stocks and the market pay attention to their valuation and what they are worth. Here is how to spot a bubble stock market top. When people are buying on cheap margin, quiting their jobs to trade full-time pay attention. When value money managers quit the game and the ones that stay adapt to high prices, at least one industry has outrageous valuations with PE's in the 50's or 100's with sustainable long-term growth only a fraction of that and initial public offerings are priced on nothing but sales pay attention and by all means sell. I'm getting a little side-tracked here but you see what I meant when I was telling you to sell the Chinese indexes and predicting a big fall back in October of 2007.

Here is the big deal. I don't think the U.S. is going to repeat the success it had in the past. As more and more emerging countries continue to challenge and dominate U.S. industry like we see with Japanese auto-makers, textiles, etc., stocks can't do what they did. Yes, the U.S. is more of a service economy and success will be different in the future but it seems foolish to bank on 9% in the next 20 years. In the beginning of this century Warren Buffett was bearish on stocks at the height of the bubble because he didn't see GDP growth accurately reflected in stock prices. GDP would either have to increase from what were record levels or stocks would come down. They came down and it seems more likely they will continue to do so.

What I recommend

If you are invested in stocks and mutual funds, read "The Intelligent Investor" by Benjamin Graham. Before you read it get a very basic background knowledge of stocks. You will understand how stock prices fluctuate irregardless to the actual worth of the company. I try and read it once a year to stay sharp and not forget what investing and stocks really are and how the market works.

Sell gains in individual stocks. Have a fair price of the company and sell when it comes close or exceeds the value. I think success in coming years is really that simple. Don't get greedy. Good things that come from greed without discipline seldom last long. Just ask Bear Stearns (BSC).

Don't expect to be rich after you retire from only buying the Dow Jones ETF (DIA) or the S&P 500 ETF (SPY). Buy specific industry and countries indexes and focus on only a few stocks. Know all you can about those 8 stocks and focus on those. Don't over diversify them. As famous economist John Maynard Keynes said, "to carry ones eggs in a great number of baskets without having time or opportunity to discover how many have holes in the bottom is the surest way of increasing risk and loss." I think it would have done a lot U.S. financial firms good to have thought about that quote over recent years as they became exposed to sub-prime loans.

International Potential

Look at international stocks like Turkeys giant Turkcell Iletisim Hizmetleri (TKC). They are a dominant telecom service provider in Turkey and Asia. With growing shareholder equity, big cash flow and solid earnings growth in the years ahead they are worth a look.

Reckitt Benckiser (RBGPF.PK) is a major home and health products company that recently bought Adams Therapuetics. They sell Mucinex which is one of the only tablet expectorant medicines on the market. The company may be insulated from a U.S. recession.

Disclosure: None

Comments

[ponchovilla]

Mark: See if you can be invited to Kudlow's Klown Show. I'll bet you wouldn't be able to speak three sentences before an argument interrupts and no one can hear what your saying.
Nice work. If you recite Graham... then either now or in the past you had (have) common sense which has more value than Platinum/oz.
Of course this is boring stuff and has little entertainment value.

[Mark Perkins]

This is my new url www.stockpursuit.com
-Mark Perkins