Markets are becoming more volatile and have moved almost sideways over the last ten years. We are presently below the all-time peak for the S&P500 of 1565.15 set on October 9th 2007. For long-term investors, there is no clear trend. The question is therefore, 'Has buy and hold become an obsolete investment thesis?
When I talk to people about investing, I am most often struck by the their lack of clear thinking in investment decisions. This article is designed to help with clarity on the decision process for long-term investors. I consider long-term investing to be investing for a period of at least 5 years, so any investments bought today would be held until 2017, at minimum.
I must first run over the known facts:
1. The recession of 2008 was the worst recession on record other than the period from 1929-32.
2. The recovery in the U.S. economy has been the slowest post-recession recovery of any period, other than the post-recession recovery of 1953. See this link for data from the Minneapolis Fed on both the recession and recovery.
3. Total U.S. debt to GDP is at all time highs. The chart is below:
One thing to note is that total debt to GDP was only just over 180% at the start of the 1929-33 crisis. In 2008, at the start of the present crisis period, it was over 350%. The present level of total debt to GDP is 352.6% (source: Fed z1 flow of funds data). The average level since records began is 206%.
4. U.S. public debt to GDP is at record non-war levels. See the chart below.
The present level is 101.5%, according to Fed data.
5. U.S. budget deficit to GDP levels are at levels not seen other than during periods of war. See the chart below.
The 2011-12 fiscal deficit is likely to be around $1.2 trillion or 7.5% of GDP.
This brings me to the crucial questions.
CRUCIAL QUESTION 1 - Do you believe that this economy is comparable to any other period in U.S. economic history?
If the answer is yes, it is comparable to other periods in U.S. history, you would be able to compare to the period that you think is the most appropriate and predict the stock market gain. This will likely mean (although the period 1966-1982 and 1929-38 are different) that you think that the size of the fall in the stock market from 2007-9 will not be repeated. The investment returns that you expect will depend on the period that you choose to compare against. Buy and hold may well be the investment decision that you favor. You have no more decisions to make.
If the answer is no, this is a period that is unique in U.S. economic history, you will need to make crucial decisions 2 and 3 to decide if a long term buy and hold investment is appropriate.
CRUCIAL QUESTION 2 - Despite the notion that this is a unique time in history (as we cannot compare it to any other period, to gain insight in to the likely result of investing in stocks), it is still safe to buy and hold as one of the following is true:
1. The economy (as described by GDP) will heal itself and the stock market will move higher as it does. Here is an analysis of the relationship between stock markets and gains in GDP. It concludes that the two are interlinked. Good growth in GDP leads to good gains in the stock market. Below is a chart of the relationship for the last 20 years.
I am not going to go into the pluses and minuses of the present U.S. economy. It is likely that the U.S. economy is presently growing at a very slow pace around 1-1.5%. There will be recessions coming our way. This is a normal economic process. The question is, "Will the growth rate overall be positive for the next 5 years at or above 1.5%?" If the answer is yes, then buy and hold is likely a reasonable investment strategy. The timing of the buy is the only decision required. This can clearly be seen from the chart above.
2. Monetary policy (money printing) will continue to be the dominant force in the market, and even if the economy remains weak for the next 5 years, the market will continue to progress. If you think growth will be below the present 1-1.5% rate, you need to ask if the present money printing exercises will remain in place and if they will continue to progress the market despite growth below the 1% level.
3. You believe that fiscal stimulus will continue at or above its present level around $1.2 trillion or 7.5% of GDP for as many years as it takes for the total debt/GDP of the U.S. to retreat to normal non-crisis levels. This will require you to conclude that there is no fiscal consolidation, until debt levels have become more normal.
To recap, buy and hold may be your choice if you think any of the following
1. The present economy is not unique and can be predicted with accuracy.
2. The economy will heal itself naturally over the next 5 years.
3. The economy will not heal naturally, but constant money printing will keep the stock market appreciating over the 5 year period.
4. Fiscal stimulus will remain in place for as long as it takes for debt levels to be reduced.
However, if you have reached this point, and do not believe in any of the propositions above, you have one last question to think about.
CRUCIAL QUESTION 3 - Savings in the economy increase by the exact amount of the fiscal deficit. In periods of high deficits, savings increase at high rates. There is an argument that all of the present 'safe assets' are actually not safe at all. These include treasuries, the dollar and real estate. This safe assets problem is made worse by the Fed buying treasuries in periods of Quantitative Easing. There is clearly a shortage of safe assets. The increasing savings glut will have to go somewhere. If the traditional safe assets are rejected, the money will go to the stock market. If you think this is the likely outcome, the market will remain strong regardless of the fundamentals. Buy and hold may still be your chosen strategy.
If you have reached here and do not believe in any of the propositions above, you should not be using a buy and hold strategy for the stock market. You should be in cash, commodities or gold.
Additional disclosure: Long (RWM), (RIMM), various U.K. corporate bonds, USD/JPY
Disclaimer - This article is not intended as investment advice. Before taking any action, please do your own research. Do not rely on any opinions or facts included in this article for decision making.