Breaking news: Stocks are making money now, but keep in mind that some investors have yet to recover from the dot-com bubble of 2000.


Jeremy Grantham is one of the most prominent permabears; he is a co-founder of Grantham, Mayo, & van Otterloo, a Boston-based asset management company that is commonly known by the acronym GMO. Grantham has a number of impressive market calls to his name, including largely avoiding the bursting of the dot-com bubble and the Great Recession. But it is not always bearish. In March 2009, the month in which the bear market triggered by the Great Financial Crisis ended, Grantham surprised many on Wall Street by writing a letter imploring managers to devise a plan to get back into stocks. This is indeed what the “permanent” people on Wall Street are asking for. They have been bearish in US stocks for several years now, and as a result, they (and their clients) have missed out on one of the strongest bull markets in US history.

As we now know, of course, US stocks have beaten inflation in recent years with historic margins. Since 2010, the S&P 500
SPX,
+ 0.06%
The inflation-adjusted total return was 12.5% ​​annualized.

Yet in most financial circles, where the “what have you been doing for me lately?” Attitude prevails. Grantham is notorious for not anticipating the bull market of the past decade. In 2010, barely a year after the start of the US bull market in March 2009, GMO predicted that US large cap stocks would barely outperform inflation over the next seven years.

GMO’s answer, in fact, is that caution might be warranted and that it would have the last word. In a recent analysis titled ‘Injuries That Never Heal’, GMO argues that something similar to the dot-com bubble burst in March 2000 or the bear market that accompanied the stagflation era for years would suffice. 1970.

Since this response is selfish on the part of GMOs, I decided to independently measure the long-term impact of living through a burst bubble. What I have found is really sobering. There have been occasions in the history of the US stock market – not as rare as we would like – where unlucky investors have lost so much that it took a generation or more to recover.

If Grantham is correct that the current stock market is forming a bubble on the verge of bursting, he is also correct that “for the majority of investors today, this could very well be the most important event. important in your life as an investor ”.

The 6% solution

Imagine an investor in December 1968 to build a portfolio that would financially support his retirement. His financial planner would almost certainly have turned to history to calculate the expected return on this portfolio, and therefore would have predicted that, aside from year-to-year volatility, the equities portion of his portfolio would produce a total return. actual annualized 6% over the following period. decades.

One way to measure the lingering effect of a bubble burst is to calculate how long it takes for the stock market to return to its long-term trendline. Since 1793, according to research by Edward McQuarrie, professor emeritus at the Leavey School of Business at the University of Santa Clara, the US stock market has produced an inflation-adjusted total return of 6.05% annualized. For illustration purposes, I’ll round this off to six percent.

I chose December 1968 to illustrate my point, because it marked a generational peak. The chart below shows this investor’s inflation-adjusted annualized total return from this month. You can see the devastation caused by the bear market of 1973-74, as well as the high inflation years of the 1970s and early 1980s. Most importantly, note that it was not until mid-1997 that the This investor’s long-term return would amount to 6% annualized. It’s been almost 30 years.

You might be wondering why I didn’t focus on the dot-com bubble burst in March 2000. The answer is that an investor unlucky enough to put a lump sum in the market at that time doesn’t have to. still not sufficiently recovered from losses to return to the 6% trendline. The actual total return for this investor since that date is 5.1% annualized. 21 years were therefore not enough to prove that the investor in March 2000 was right, who based his financial future on the extrapolation of the long-term past.

Who still believes in 6%?

You might also object to the sobering message of my analysis on the grounds that no one expects the stock market to produce a real long-term total return of 6% annualized. In the low interest, low growth world we live in today, one might say, it is unrealistic to expect the future performance of the stock market to be as impressive as it has been in the past.

However, old beliefs die hard. You would be surprised to learn that many financial planners continue to make financial plans for their clients on the assumption (implicit if not explicit) that the future looks like the past. This is also the implicit assumption behind the downward trajectories followed by many target date retirement funds that are so popular with investors and 401 (k) retirees.

However, your objection is not unfair. So it’s also worth focusing on how long it takes investors to break even after a bubble burst.

Better than the almost 30 years it took for one unlucky investor in December 1968 to get back to the 6% trendline, but not by much.

Fortunately, most of the work for these calculations was done by McQuarrie. For the period dating back to 1793, he calculated the longest period in which the inflation-adjusted total return of the stock market was less than 1% annualized. The longest was the period beginning with the crash of 1929: from that date until 1949, the stock market produced an inflation-adjusted total return of 0.75% annualized – 20 years, in d ‘other terms.

None of this tells us if we’re in a bubble, of course. This discussion only shows that being cautious for a decade is not an automatic reason to conclude that the advisor has betrayed his clients.

Bubble problem?

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