The Pros and Cons of Buy and Hold vs. the Next Bear
by the Curmudgeon with Victor Sperandeo
Many investment advisers now advocate a buy and hold approach to the stock market. One can certainly appreciate that in the eighth year of a bull market that has seen stock prices more than triple from the March 2009 lows.
In an August 21st NY Times print edition article titled The Obama Years: The Best of Times to Be a Stock Investor Jeff Sommer writes:
The facts are inescapable: The Obama years have been among the best of times to be a stock investor, going all the way back to the dawn of the 20th century.
Since 1900, the Obama presidency has so far been the third best for stock investors. Using the Dow Jones industrial average, market performance has been better only during the presidencies of Calvin Coolidge, a Republican, in the Roaring 20s; and Bill Clinton, a Democrat, from 1993 to early 2001, years that encompassed the tech bubble.
A crucial factor (for the stock market rise under Obama) is that the Federal Reserve, which the president does not control directly, embarked on an extraordinarily accommodative monetary policy, starting even before Mr. Obama took office. On Dec. 16, 2008, for example, one month after the presidential election, the Fed brought short-term rates sharply lower, close to zero.
Fed interest rate policy may be the single most important factor behind the stock market boom. And even if Mr. Obama does not control the Fed, he did reappoint Ben S. Bernanke as Fed chairman in August 2009. In October 2013, the president appointed Janet L. Yellen as Mr. Bernankes successor. Under both, the Fed has held interest rates very low, which is helping to buoy the stock market and may be affecting the presidential election, as Ned Davis Research suggests in a recent note to clients.
Obviously, not everyone agrees with Buy and Hold. The venerable Dow Theory Letters (DTL), published since 1958, states on their website home page:
We believe in market timing. Our goal is to get you out at the top and in at the bottom of major, long-term market moves.
DTL now says two of their key stock market indicators are not in sync. Their Primary Trend Index (PTI) is BULLISH, but the Dow Theory is still on a SELL signal as the Dow Transports have not confirmed the new high in the Dow Industrial average.
Other advisory services take a more subdued approach (vs. market timing) by always maintaining a core position in stocks and varying the percentage invested according to some combination of fundamental and technical analysis, valuations, investor sentiment, market cycles, age or earned income of the investor, etc. The goal is to balance risk (amount you can lose) vs reward (amount you can gain) in ones allocation to stocks, ETFs, or equity mutual funds.
Buy and Hold HAS BEEN a Winner, but Consider the Pain of Bear Markets (Victor):
Certainly over the last 7.5 years, a "buy and hold" strategy in a broad stock index like the S&P 500 or the NASDAQ 100 has been a big winner as the NY Times article noted above confirms.
Since 1982, buy and hold HAS BEEN (emphasis added to imply past tense) a winning strategy. However, suffering the amount of pain through severe bear market declines are based on your temperament and your age.
If you are 22 years old, fresh out of college, working, and secure in your self-esteem then investing savings over the next 40 years is creates one type of emotional temperament.
But at 65+ and in retirement being involved in the equity market is quite another story. This is called a factual context. When you need the savings to survive your non-working older years, money becomes a necessity. Far different than working and beginning a career. Therefore, buy and hold must be perceived in this context.
Economic Recoveries Favor Buy and Hold (Victor):
It should be noted that economic recoveries/expansions have lasted far longer since Alan Greenspan1 led the Fed kingdom (he was actually knighted) and he invented aggressive "Central Planning" tactics to keep recoveries going. Unfortunately, he didnt mention the eventual costs. Please see the Sidebar for my thoughts on that.
Note 1. Greenspan was appointed as Chairman of the Fed on August 11,1987 and served in that position for 19 years.
From 1982 to date (34 years), the "average" economic recovery is 92 months. With much longer economic recovery from 1982 till today, a buy and hold strategy was the correct policy as stocks rise during economic expansions (especially the current one which is the weakest in all of US history!).
Lets digress to look at past economic recoveries/expansions:
According to the National Bureau of Economic Research (NBER) Business Cycle Dates, the length of the recoveries has been
Astonishingly, the median length recovery was a mere 27 months from 1854 to 1982! Of the 33 occasions before 1982, only two recoveries lasted for a long time in relative terms: 80 months and 106 months.
Fed chairs Greenspan, Bernanke, and Yellen have extended the recoveries by 3.5X's from the median in the last 129 years to 1982. This suggests "buy and hold' WAS a very successful strategy. Warren Buffett is living proof, as he bought and held stocks from the 1974 lows. Hes the second or third wealthiest ranked man in the world!
Sidebar: Whats the End Game for Fed Policy? (Victor)
But at what future cost? As Captain Kirk, captain of the Star Ship Enterprise in Star Trek, put it..."and boldly go where no man has ever gone before."
The control and use of the printing press has gone beyond anything the imagination could have dreamed, as the Fed held rates lower for longer, while the federal government increased its massive government debt. The (privately owned) Fed printed money (by creating additional bank reserves via book entry) to buy government debt and mortgages, which thereby permits the creation of more debt.
The cost of all this has been pushed into the future (AKA kicking the can down the road). The negative consequences may be realized under a different Fed Chair, who will be condemned for what others before primarily caused. It will be paid for by all citizens rich and poor someday. It is such a bizarre, and an outlandish policy that one has to ask if the objective is to take down the country with a crash?
Recent Fed policy seems analogous to a Fabian strategy.2"
Note 2. The Fabian strategy is a military strategy where pitched battles and frontal assaults are avoided in favor of wearing down an opponent through a war of attrition and indirection. Fabian Socialism, the ideology of the Fabian Society which originated in 1884 and launched the Labour Party in the United Kingdom in 1904, utilizes the same strategy of a "war of attrition" in their aim to bring about a socialist state.
The only "fundamentally driven" reason for the extraordinary easy Fed monetary policy is to believe that the Fed would never allow a recession after 2008, i.e. they would do whatever it takes to prevent one. If one believed and understood this mentality, then that person is the smartest man in the room.
Also, to believe that the US would not put fiscal policy on the table, when monetary policy has empirically been an abject failure, was not assumed by anyone I have seen or read. In particular, the absence of any tax policy to help improve the economy from its managed decline (or its death spiral) seems to be due to an ideological agenda of those in power.
Coping with Severe Bear Markets (Curmudgeon):
As Victor notes above, many investors cant maintain a buy and hold strategy, because they cant emotionally and/or financially suffer through a prolonged stock market decline. At some pain point or stop loss limit, investors will sell stocks to prevent further losses. Theres an immediate feeling of relief that many seasoned investors (who have been through severe bear markets) can certainly appreciate. If nothing else, the gut churning and worry stops -at least for a while.
Here are a few noteworthy examples of severe bear market declines:
1. September 1929 to June 1932
The stock market crash of Oct. 29, 1929, marked the start of the Great Depression and sparked America's most famous bear market. The S&P 500 fell 86 percent in less than three years and did not regain its previous peak until 1954.
S&P 500 high: 31.86, Low: 4.4, Loss: 86.1%, Duration: 34 months
2. January 1973 to October 1974
Israel's Yom Kippur War and the subsequent Arab oil embargo sent energy prices soaring, sparking a lengthy recession. The annual consumer inflation rate topped 10 percent. The Watergate scandal forcing President Nixon to resign.
S&P 500 high: 119.87, Low: 62.28, Loss: 48.0%, Duration: 21 months
3. August 1987 to December 1987
After a prolonged bull run, computerized "program trading" strategies swamped the market and contributed to the Black Monday crash of Oct. 19. Investors were also nervous after a heated debate between the U.S. and Germany over currency valuations, sparking fears of a devaluation of the dollar. As a result, the Dow fell 22.6 percent -- the worst day since the Panic of 1914. Yet while the days after the crash were frightening, by early December the market had bottomed out, and a new bull run had started.
S&P 500 high: 337.89, Low: 221.24, Loss: 33.5%, Duration: 4 months
4. March 2000 to October 2002
The bursting of the dot-com bubble followed a period of soaring stock prices and exuberant speculation on new Internet companies. Companies with little or no profits had market values that often equaled or exceeded that of established "old-economy" corporate giants. The Nasdaq composite index, which soared in value thanks to the listings of hundreds of tech start-ups, plunged over 50% in nine months.
S&P 500 high: 1527.46, Low: 776.76, Loss: 49.1% Duration: 30 months
5. October 2007 to March 2009
A long-feared bursting of the housing bubble became a reality beginning in 2007, and the rising mortgage delinquency rate quickly spilled over into the credit market. By 2008, Wall Street giants like Bear Stearns and Lehman Bros. were toppling, and the financial crisis erupted into a full-fledged panic. By February the market had fallen to its lowest levels since 1997.
S&P 500 high: 1565.15 on Oct. 9, 2007, Low: 682.55 on March 5, 2009, S&P 500 loss: 56.4%, Duration: 17 months
→Now ask yourself (objectively): could you stomach another 40% + decline in your stock portfolio?
Victors Perspective: Holding stocks for the long term (quotes from 1992)
From Victors famous 1992 interview with Jack Schwager in the classic New Market Wizards book:
Schwager: "What's the greatest misconception people have about the stock market?"
Sperandeo: "The idea that if you buy and hold stocks for long periods of time, you will always make money. Here are two specific counter-examples:
1. From 1896 low to 1932 low (36 years)
From 1929 to 1932, the market dropped an average of 94%.
2. From 1962 low to 1974 low (12 years)
During the 1973-74 bear market, the "nifty fifty" stocks lost greater than 75% of their value.
Curmudgeon Note: Also from December 1965 DJI high of 969.26 to the August 12, 1982 DJI low of 776.92 (almost 17 years), you would've lost money in the stock market-even including dividends! Note that in 1982 there was only one stock index mutual fund- the Vanguard Index Trust (S&P 500 Index).
Schwager: "Could we get a bear market that would be far worse than most people could imagine?"
Sperandeo: "Exactly. People who have the notion that buy and hold for the long term could easily go bankrupt."
Curmudgeon Note: The above interview was conducted long before ZIRP, QE, negative interest rates, Central banks buying ETFs and stock index futures, and other clandestine and stock market supporting monetary policies.
Victors Update and Thoughts on the Next Bear Market:
The depth, duration and recovery length of a bear market is not predictable. It is based on government fiscal and monetary policies to get the economy back on a growth trajectory. For hundreds of years that was the 2+2 model. After the Obama agenda that might no longer be true.
It is my very strong opinion the next bear market will be the worst in all of history. Why? The US federal government is out of ammo.
So forget using the history to judge past bear markets in order to gauge future bears. This is a whole new ball game!
Stock Market vs the Economy (Victor):
Recently, US equity markets have gone up substantially for no obvious reason. With the weakest US economic recovery ever, with 1st half GDP at only 1%, the US stock market has rallied strongly off its Feb 11th low this year.
Curmudgeon Note: One explanation we saw this past week via Zero Hedge was from Barclay's chief equity strategist Keith Parker. His answer: stock index futures buying (which has traditionally been associated with central bank intervention). To the tune of $60bn notional since March 2016. That has surpassed the amount of buying between October 2011 and May 2013. Together with short-covering, it has more than offset the $128bn of outflows from US equity mutual funds since mid-March 2016.
In a great article that gives us a clue to what may be ahead, Lee Adler wrote:
Joe Granville once asked, and answered:
What does the stock market have to do with the economy? Absolutely nothing!
I would only partly agree. Because the Fed follows and ultimately will react to strengthening economic data by beginning to tighten monetary policy in earnest.
Curmudgeon Note: Fed tightening, if it persists, is not bullish for the market! However, Victor and I dont see any sustained Fed tightening anytime this year.
This quote from someone who later became the 2nd US President shows how cynical our Founding Founders3 felt about men in power, even when it was themselves. John Adams said
"I have accepted a seat in the House of Representatives, and thereby have consented to my own ruin, to your ruin, and to the ruin of our children. I give you this warning that you may prepare your mind for your fate."
Note 3. The U.S. Founding Fathers include George Washington, John Adams, Thomas Jefferson, James Madison, Alexander Hamilton, James Monroe and Benjamin Franklin. John Adams (not John Quincy Adams) served as George Washington's Vice President for two terms before he became the second President of the United States.
Victors Closing Comment:
Power is the most cut-throat and number one desire of mankind. In the quote above, John Adams clearly recognized that. But do our current leaders?
And we allow the Fed -a private bank -to run our paper currency, set interest rates, and do whatever it wants in secret without even an audit?
Good luck and till next time...
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Curmudgeon is a retired investment professional. He has been involved in financial markets since 1968 (yes, he cut his teeth on the 1968-1974 bear market), became an SEC Registered Investment Advisor in 1995, and received the Chartered Financial Analyst designation from AIMR (now CFA Institute) in 1996. He managed hedged equity and alternative (non-correlated) investment accounts for clients from 1992-2005.
Victor Sperandeo is a historian, economist and financial innovator who has re-invented himself and the companies he's owned (since 1971) to profit in the ever changing and arcane world of markets, economies and government policies. Victor started his Wall Street career in 1966 and began trading for a living in 1968. As President and CEO of Alpha Financial Technologies LLC, Sperandeo oversees the firm's research and development platform, which is used to create innovative solutions for different futures markets, risk parameters and other factors.
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