Prophets of doom look forward with trepidation to the day that begins 48 hours before Christmas in 2012. The date represents the fateful day that the Mayan calendar reaches its conclusion; those who follow the writings of the Maya Indians, who once ruled over much of Central America, believe that geological catastrophe lies ahead. Back in the decidedly more mundane world of finance, perhaps the Mayans foretold a resumption of the secular bear market in global equity markets that began more than a decade ago.
In a similar vein, Citigroup’s investment division published a report last Friday that called time on the ‘cult of equity’; a tad tardy one might argue, but better late than never. Strategists at the financial conglomerate trace the birth of the ‘cult of equity’ to the late-1950s, when inflation-adjusted stock prices finally eclipsed their 1929 peak and the investing public began to appreciate the merits of equity investment. Fast forward to today and equity mutual funds are on course for the third consecutive year of negative cash flows, as the investing public continues to exit the stock market.
The investment report captures the essence of the secular debate, but omits the twists and turns in the primary trend that have taken place over the past half-century. This movie has screened before and the current secular downtrend is the second primary bear market since the late-1950s and the third of the past 80 years. Just as before, the investing public has reacted with a considerable lag to a structural break in the primary trend; they typically return for a second beating after the first bear shock, albeit less enthusiastically than before, but twice bitten and thrice shy.
It took investors a considerable period of time to erase painful memories of the ‘Great Depression,’ and only the 1950s – the best decade of stock market returns relative to Treasury bonds on record – managed to entice them back into the equity market. The investing public poured monies into equity mutual funds through the go-go years of the 1960s; stocks became the investment vehicle of choice as enthusiasts hailed the arrival of a ‘new era’ and with it, the eradication of business cycles.
The optimism proved misplaced and economic volatility returned as inflation spiralled out of control. The investing public took the 1966 bear market in its stride, but a further year of negative returns in 1969 contributed to a surge in equity mutual fund redemptions and the industry suffered its first annual cash outflow in post-war history.
The exodus continued throughout the 1970s, and accelerated following the sharp decline in stock prices mid-decade. Indeed, Business Week reported in the summer of 1979 that, “At least seven million shareholders have defected from the stock market since 1970.” In the same year, the total net assets of money market mutual funds exceeded those of equity mutual funds, as the investing public’s appetite for risk simply disappeared.
The secular bear market ended in the early-1980s, but it took almost a decade of strong returns before the investing public embraced equity investment again. Equity fund sales soared during the 1990s, as talk of a ‘new era’ moved centre-stage, and even Alan Greenspan, the then-Federal Reserve Chairman, appeared to have bought into the brave new world. Equity fund sales increased from less than $8 billion a month at the start of the 1990s to roughly $4 billion every business day by the decade’s end.
A “buy on the dips” mentality became deeply ingrained in the investing public’s psyche; being out of the stock market was considered a more risky proposition than being in the stock market. Three consecutive years of negative returns dented the belief that persistent double-digit returns are carved in stone, but following just one year of cash outflows, equity fund sales picked-up once again. However, a further collapse in stock prices has left deep scars, and bullish optimism that the investing public would channel their high liquidity balances into equity funds has by now been dashed.
Individual investors were duped into believing more than a decade ago that stocks were the safest asset for long-term investors, but the negative return generated by stocks over the past decade has revealed that the long-run may simply be too long. The same arguments were espoused at the height of the secular bull markets of the 1920s and 1960s, but careful examination of the subsequent data reveals that equity investment is not a guaranteed route to wealth generation.
Consider that an investment in the U.S. stock market at the end of 1928 did not breakeven in inflation-adjusted terms until 1944, or that equity purchases made at the end of 1968 remained underwater in real terms until 1983. However, the investing public does not accumulate stocks simply to maintain purchasing power and realising the average historical return is likely to be the minimum objective. It took the 1928 investor almost seven decades to attain that goal, and following the disappointing market performance in recent years, the 1968 investor is still waiting.
The words of John Maynard Keynes seem apt; “In the long run, we’re all dead.”
Secular bear markets are painful events and the evidence reveals that an investing public twice bitten is thrice shy. The ‘cult of equity’ is dead.
The views expressed are expressions of opinion only and should not be construed as investment advice.© Copyright 2010 Sequoia Markets
Disclosure: No Positions
Disclosure: No Positions