ING DIRECT SHAREHOLDER SURVEY
Before covering the stock market’s performance in bull and bear markets, let’s first begin by reviewing the results of a survey of 1,021 young (ages 21 to 39 years) and old (ages 40 to 65 years) investors conducted by ING DIRECT to obtain their views about investing in the stock market. The study was conducted online from January 7 to 19, 2010, ten months after the market bottomed in March 2009. The survey questioned these investors on the following subjects: confidence and optimism, influencers, motives, barriers, and expected returns.
The key survey findings were as follows:
- 43 percent of those 21 to 39 years of age plan to invest more in 2010 compared with 33 percent of those 40 to 65 years of age.
- 26 percent of younger investors and 28 percent of older investors expect an annual return of between 10 and 20 percent.
- Older investors are leading the trend to become selfdirected investors. Almost half (49 percent) of those 40 to 65 years of age have reduced or eliminated their reliance on financial professionals compared with 37 percent of investors aged 21 to 39 years.
- Younger investors currently rely more on financial Web sites and blogs (49 percent) and financial print publications (39 percent) than on financial planners or advisors (35 percent) or brokers (18 percent) for investing advice.
- Investors aged 40 years and older also rely more on financial Web sites and blogs (47 percent) and financial print publications (41 percent) than on planners or advisors (39 percent), brokers (36 percent), and family (19 percent).
- On average, investors think that they need $699 to get started investing.
- Almost half (48 percent) of younger investors think that they need more than $500 to start investing compared with 56 percent of older investors.
- Almost half (44 percent) of those with access to an automated platform that enables investing in small dollar amounts say that you can get started with just $100 or less.
- Almost one-third (30 percent) of the younger group say that their parents had the biggest influence in getting them started investing.
- 17 percent of investors 40 to 65 years of age say that their parents had the largest influence in getting them started investing.
- 81 percent of respondents who own a brokerage account and who are fully employed have a retirement account:
- 34 percent are between 35 and 44 years of age, whereas 77 percent of those with no 401(k) account are older or younger than Generation X.
- 47 percent earn at least $125,000 annually, compared with just 25 percent among those who do not own a 401(k).
- 56 percent have at least a college degree or more education compared with 41 percent among those who do not own a 401(k).
- Over half (52 percent) of investors plan to invest about the same amount in 2010 as they did in 2009, and surprisingly, about 4 out of 10 (37 percent) plan to invest more.
- Just 11 percent say that they plan to invest less in 2010.
- Younger investors are even more optimistic. Forty-three percent of those 21 to 39 years of age plan to invest more in 2010 compared with 33 percent of those 40 to 65 years of age.
- More than 6 in 10 (63 percent) either plan to make no changes in their approach or plan to take a more aggressive approach to what they perceive as a buying opportunity.
- 22 percent say, “I think now is a great time to invest. I’m taking a more aggressive approach.”
- Another 41 percent say, “I believe in a long-term view when it comes to investing, so I’m not making any changes to my investments.”
- Just 5 percent indicate they have headed to the sideline with their choice of the statement, “It’s too risky. I don’t want to invest right now.” Thirty-one percent say, “I’m more conservative than before, but it’s still okay to invest.”
- .61 percent of investors expect an annual return of between 5 and 10 percent on their money.
- 26 percent of younger investors and 28 percent of older investors expect an annual return of between 10 and 20 percent. The weighted-average return is 11 percent, considering all responses.
- 45 percent of investors have either reduced or eliminated their use of financial professionals for investing advice. Older investors are leading this trend. Almost half (49 percent) of those 40 to 65 years of age have reduced or eliminated their reliance compared with 37 percent of investors aged 21 to 39 years.
- 62 percent of younger investors indicate that the cost of advice was the reason they reduced or eliminated their reliance on financial professionals for investing advice. By comparison, 57 percent of investors 40 to 65 years of age feel that they can do just as good a job on their own.
- Family members (40 percent) are being used by more young investors for advice than brokers (18 percent). Investors aged 40 years and older also rely on financial Web sites and blogs (47 percent) and financial print publications (41 percent) more than planners (39 percent), brokers (36 percent), and family (19 percent).
SURVEY OF AFFLUENT INVESTORS INDICATES CONCERNS
Let’s look at another survey of investors that focuses only on more affluent investors. Merrill Lynch Affluent Insights Quarterly Survey results were based on interviews with 1,000 affluent investors with investable assets of at least $250,000 on June 11 and 29, 2010, and another 300 Americans in each of 14 target markets. The source of this information is a Bank of America press release dated July 28, 2010, sent over Business Wire.
The key findings of their survey are as follows:
- 70 percent of those surveyed do not believe that their retirement plans take into account the potential for unexpected family events (e.g., serious illness, divorce, caring for parents), but 35 percent have adjusted their priorities accordingly.
- 51 percent of couples disagree with each other on making investment decisions, how best to save and invest for retirement, sticking to family’s budget, and paying off credit-card debt.
- 51 percent cited “financial know-how” when asked about important life lessons to impart to their children.
- 39 percent of parents were spending more time discussing financial matters with their children in light of current economic conditions.
- 74 percent of parents shared advice from their financial advisor to educate their children.
- 50 percent of respondents had a low risk tolerance and used conservative investment vehicles and strategies; this compares with 52 percent of younger persons (ages 18 to 34 years), who have a similar risk tolerance; 45 percent for 35- to 50-year-olds; 46 percent for 51- to 64-year-olds; and 55 percent for those age 65+.
- Both younger and affluent individuals (56 and 46 percent, respectively) are more conservative investors now than one year earlier.
- 45 percent of respondents are planning to delay their retirement compared with 29 percent in January 2010.
- 69 percent of the affluent want their financial advisor to be proactive with investment advice, and 68 percent want advice on how to maximize their 401(k).
STOCK MARKET REALITY AND FORECASTS
In March 2000 and October 2007, investors had no idea that the next two to three periods would result in two horrendous bear markets. Just look at the massive devastation inflicted on investors during that combined period, where a total of $14 trillion in market value was erased in only 32 months from peak to trough in the 2000–2002 crash and in only 17 months in the 2007–2009 crash. The last crash has been the worst in percentage terms since the Great Depression.
During 1999 and 2000, the stock market and especially the “hot” Internet stocks were the topics of conversation at supermarkets, bowling alleys, bars, and hair salons all across America as the market soared to unprecedented heights. CNBC replaced the “soaps” as the most popular daytime entertainment medium, with its streaming stock quotes and never-ending procession of bullish market strategists, bullish financial analysts, and bullish CEOs.
Euphoria was in the air, and life was great for millions of retirees and regular folks who had started investing over the past 20 years, and especially day traders, who were racking up huge gains as stocks advanced day after day. That all came to a screeching halt, though, when the big bear started growl ing in April 2000, when the Nasdaq Composite dropped a jaw-dropping 25.3 percent during the week of April 14. The bear then unceremoniously clawed the market over the next few years.
The market’s upswing finally began in October 2002, but there was another drop into March 2003 before the market started its slow rise to a recovery peak in October 2007, only to crash again to new lows by March 2009. At that point, a huge rally took place, vaulting the market by 90 percent from those lows by December 2010.
Many investors were so scared by the two most recent bear markets that they did not participate in the market’s rise from the March 2009 lows; as they did not put money into equities but rather concentrated on building their cash and bond positions. Such a conservative approach allowed them to sleep better at night but cost them big gains, which don’t come along very often.
INVESTORS ARE TOO EMOTIONAL AND OVERCONFIDENT
Whether you believe it or not, the stock market is a very difficult place to consistently make money unless you have a strategy that works. This is not a new thought. Over the past 100 years, the stock market has been punctuated by sharp, uplifting bull markets, followed by swiftly plummeting bear markets. This cycle has happened in the past, and it will happen in the future—for, after all, the markets are driven by people’s emotions and actions. Market cycles repeat themselves, just as history repeats itself. People are people, and where money is at stake, people react emotion ally, which usually results in bad decision making. Investors have a poor track record of making money in the stock market.
Numerous surveys have shown that investors buy and sell at the wrong times, and they usually buy and sell the wrong investthe incorrect decisions that investors are prone to make are the result of overconfidence in their investment knowledge, overtrading, lack of diversification, and incorrect forecasting of future events based on recent history. Stock market success requires that investors act inde pendently of the crowd and rein in their emotions. If fear and greed are not eliminated from the investing equation, the results can be cata strophic. Unfortunately, investors will continue to make the same mistakes over and over again. This is just the way it is.
Robert Safian in a January 2003 Money magazine article said: “All across America, millions of people are afraid to open their account statements, afraid to look at their 401(k) balances—afraid to find out what they’ve lost during this long bear market and where they stand today.”1 This is a pretty sad state of affairs. However, it did not have to be that way if investors would only have had an investment plan that forced them to take profits as stocks kept going up, and they had placed stop-loss orders on their stocks to protect their positions as prices collapsed. But most investors froze and did nothing until the market was well off its highs. Then, as the market hit subsequent lows in July and October 2002, investors took their billions of dollars out of equity mutual funds and began investing their money in bonds and money-market funds. Other investors just gave up and cashed in all their investments, having endured severe emotional and financial pain.
The vast majority of individuals are not savvy investors, even though many have above-average intelligence and consider themselves to be above-average investors. They do not have the time, background, or expertise to assess the market at key turning points (e.g., whether the bull market is beginning or ending). Moreover, the average investor’s performance typically is worse than the appropriate market benchmark or even the actual performance of his or her mutual funds. This outcome is a result of poor timing on entry and exit points and lack of a coherent, well-researched strategy. Most investors buy and sell on a whim, or they take advice from a friend or CNBC, or they act based on hearing an “expert” giving his or her opinion on the market or a particular mutual fund or stock in the media.
Investors need a methodology to know when to buy and sell, but only a few investors have even thought about it, let alone have a methodology in place. Unfortunately, investors as a group invest and hope for the best. This approach is no way to build a nest egg for the future but rather is a recipe for financial disaster. You wouldn’t leave your garden untended because you know that weeds will grow and kill your flowers and vegetables. The same logic applies to your investments. Being proactive is better than being nonactive. This is not to say that you should be an active trader or an aggressive investor but rather that investing is not a static endeavor. You should watch over your investments, making adjustments as necessary to weed out the dead wood and replacing it with more fruitful pickings. You are the best gardener for your investment patch. Don’t let the experts tell you otherwise.
Just because you bought shares in high-quality companies doesn’t mean that you made smart investments. Even the so-called blue chips had plummeted from their 2007 highs to much lower levels by March 2009. General Electric went from $42 to $6, Goldman Sachs went from $250 to $46, and AIG hit $1,400 before dropping to $0.35 (both prices split-adjusted). This type of devastation doesn’t have to happen to you if you become a smarter investor going forward. Surely, by heeding the advice of the Wall Street intelligentsia, you can come out way ahead, right? Wrong!
MARKET SEERS ARE AN EMBARRASSING LOT
Think about all the stock market experts’ market predictions you’ve read or heard about over the past few years. A handful of these char acters have been let go or have changed firms. Even some well-known technicians do not have very good track records calling the market top. BusinessWeek published a year-end review for each year from 1999 through 2002 showing the market predictions of stock market experts for the upcoming year. In all the years, the experts had a poor track record because most were bullish, and their projections of the market’s performance were way off. I haven’t seen any surveys like this in the past few years. I wonder why?
BusinessWeek also published a list of the experts’ individual predictions in its year-end issue. The number of prognosticators tracked by the magazine for the years 2000 through 2003 has var – ied between 38 to 65, with 50 being the average. This list represented a solid cross section of well-known market strategists at that time, including Joseph V. Battipaglia, Elaine Garzarelli, Edward Yardeni, Bernie Schaeffer, Edward Kerschner, Lazlo Birinyi, Jr., Hugh Johnson, Philip J. Orlando, and Jeffrey Applegate.
Table 1-1 shows the composite results of all their forecasts over four years for the Dow Jones Industrial Average (DJIA), the Standard & Poor’s 500 Index (S&P 500), and the Nasdaq Composite Index. The table delineates for each year the high, low, and con – sensus forecast of all the forecasters for each of the three popular market averages. As you can see, starting with the first forecast for the 2000 stock market made at the end of 1999, the forecasters had a poor record. In fact, in each of the last three years their forecasts have gotten progressively worse. Forecasters, as a group, were sim – ply overly optimistic. There are always a few bears around, but even the bears did not predict the actual lows of the market in 2002. The most inaccu rate predictions were for the Nasdaq; the actual close compared with the consensus forecasts was off by 54 percent in 2000, 84 percent in 2001, and 67 percent in 2002. In conclusion, the “best and the brightest” appeared to be not so bright or right. To be fair, their actual stock picks for their clients could have been quite different and perhaps closer to the mark. For the sake of their clients, I hope that was the case.
STOCK RETURNS VARY BY DECADE
Stock market yearly returns are not consistent; in fact, they vary all over the map. This fact is what drives investors crazy. They never seem to know if they should be buying or selling. Listening to the advice and predictions of the Wall Street crowd further confuses investors. If investors are fully invested during uptrends, they can experi ence excellent returns. Unfortunately, the downtrends can take away a good portion of their gains if they just follow the buyand- hold approach. Consider the wide variance in average annual stock market returns during the eight decades since the 1920s, as shown in Table 1-2.
The 1950s, the 1980s, and the 1990s produced above-average returns in the neighborhood of 18 percent, whereas on the flip side the 1930s, 1960s, and 1970s, and 2000s provided less-than-stellar returns. The 1940s provided a return close to the 9.89 per cent annual return of stocks between 1926 and 2010. As you can see, the 1995–1999 period was an anomaly that produced abnor mally high returns for those who stayed fully invested during that time period. Since the beginning of 1995, had those same investors been holding their stocks and mutual funds through October 9, 2002, they would have sustained substantial losses depending on their
investment portfolio mix. (Remember that many investors had high exposure to the technology sector.)
STOCK RETURNS FROM 2007 THROUGH 2009
The three major market averages performed horribly in the last bear market, each off by over 50 percent. Table 1-3 shows the widespread devas tation from the highs to the lows. For just the year 2008 (not shown in the table), the Nasdaq Composite Index was down 38.5 percent, the S&P 500 Index was down 38.9 percent, and the DJIA fell 33.8 percent. To be fully invested in stocks, stock mutual funds, or equity exchange-traded funds (ETFs) during a severe bear market such as this one is a frightening experience and one that should be avoided. Based on what you hear from the socalled experts, there is no way to know when a bear market is coming or its duration. The “experts” keep professing that buy-andhold is the way to go because in the long run you’ll do fine.
THE STOCK MARKET CONFOUNDS MOST INVESTORS MOST OF THE TIME
The stock market confounds most investors most of the time, and it will continue to do so in the future. This is so because the markets are driven by investor psychology and perception of events. When good news comes out about a stock, sometimes its price rises, and sometimes it falls. When the Federal Open Market Committee (FOMC) of the Federal Reserve cuts interest rates, as
it has on many occasions in the past few years, sometimes the market rises and closes up for the day, and sometimes it falls and closes down for the day. In this respect, the market is unpredictable, and this con fuses investors, as well as the so-called professionals, although they may not admit it.
The market is a discounting mechanism and is always looking ahead, not backward in the rearview mirror. Thus news, whether good or bad, will have an impact on the market in the short run. In the long run, though, growth in corporate earnings and dividends, coupled with a sound economy with low interest rates and low inflation, is what will drive stock prices much higher. Uncertainty caused by domes tic and global political, economic, and social events will alter the market’s course for days, weeks, or months, depending on the severity of the problem perceived. And when least expected by the vast majority of investors and professionals, the market will turn around and make a new bull run, with deceiving dips along the way to shake out the weak hands. And market bottoms usually occur when investor pessimism is at its highest, all the news is bad, and no one wants to own stocks, as in March 2009. Perception is what drives markets, not reality. Therefore, the market races ahead while investors are hoarding their cash.
BULL AND BEAR MARKETS
Looking back, many middle-aged and older investors participated in the great bull run through 2000. From October 11, 1990, until January 14, 2000, the DJIA rose a cumulative 396 percent. From 1995 through 1999, the S&P 500 Index rose at a 28 percent annual compounded rate. In 1999 alone, the Nasdaq Composite Index jumped an astonishing 85.6 percent. This was its largest yearly increase since the index was created in 1971. Investors should have been extremely cautious in 1999 after such a huge unprecedented run-up, but they were net buy ers of stock rather than net sellers right at the market top because of the unabashed euphoria, greed, and the bullish gurus.
Don’t forget that a 50 percent loss in a stock requires a 100 percent gain, just to break even. And in the case of a 75 percent loss, a 300 percent gain is needed to break even. To recover from this magnitude of loss usually takes years. Fear and greed are factors that are at play when humans are involved, and this fact will never change.
STOCK MARKET PERFORMANCE OVER 110 YEARS
How has the stock market performed over the past 110 years? To gain a perspective on the magnitude of bull and bear markets, consider Tables 1-4 and 1-5. The data were provided by the Hays Advisory Group, and the tables show all the bull and bear markets in the twentieth century, using the DJIA as the benchmark. Neither the S&P 500 nor the Nasdaq Composite Index had historical data that far back in time; therefore, the DJIA was used instead.
Market academicians define a bear or bull market as a decline or rise of 20 percent, respectively, in a major market index. Table 1-4 adheres to this classification, but Table 1-5 has six time frames in which the change in percentage was less than 20 percent. Since Hays provided the data, I did not adjust them.
As Table 1-4 indicates, there have been 29 bull markets from 1900 through 2009, with an average gain of 90.3 percent and an average duration of 29.9 months (2.49 years). The average gain is skewed by the superbullish May 1926–March 1937 time frame, in which the cumulative return was over 459 percent, and the November 1990 through July 1998 time frame, where the return was 300 percent. Be aware of this fact when comparing bull markets with each other.
Looking at the bear market scenario in Table 1-5, we find that there have been 29 bear markets, with an average drop of –30.8 per – cent. The largest decline ever was when the market tumbled 90 percent from September 1929 to July 1932. The next worst was the most recent bear market, with a drop of 54 percent. The previous bear market, ending on October 9, 2002, produced a drop of 38 percent for the DJIA, but the S&P 500 Index fell 49 percent during this time frame and the Nasdaq Composite got clobbered, dropping 78 percent.
The average bear market has lasted 17.3 months, with an average fall of 30.8 percent. But there have been some catastrophic bears, including the 35-month bear market from September 1929 to July 1932, the 13-month bear mar ket from March 1937 to March
1938, the 24-month bear market from January 1973 to December 1974, and of course, the last two bear markets since 2000.
Bear markets drops are much faster than bull market rises. For example, from January 1, 1991, to March 31, 2000, a period of 9.25 years, the S&P 500 rose from 330.22 to 1498.50 points, a total gain of 1168.28 points, resulting in a gain of 353 percent. In stark contrast, from the end of June through the end of July 2002, the S&P 500 fell 266 points, a loss of approximately 23 percent of that entire gain over a period of just two months. That’s volatility in a bear market! In the fourth quarter of 2008, the S&P 500 produced the worst quarterly results in 21 years, with a drop of 22.6 percent.
BEAR MARKET RECOVERIES
Table 1-6 provides data on how long it takes to break even, assuming a buy-and-hold approach with the S&P 500 Index, once a bear mar ket has reached bottom. Also shown is the combined time of the drop and the time to recovery. Unbelievably, it took over 25 years for buy-and-hold investors to break even from the ravages of the Great Depression. (Note: The 25 years does not include a calculation for reinvested dividends, which would have shortened the period.) Do you really want to wait this long just to get your money back, assum ing that you didn’t sell at the bottom and didn’t get back in the market? Do you think the average investor was able to take the pain of an 86 percent drop and wait 25 years? I certainly don’t.
From 1956 through March 2009, the average bear market lasted 341 days (0.98 year), resulting in an average loss of 34.3 percent. The average recovery period to reach the previous high was about 986 days (2.74 years).
Note that in every case it took more recovery time than the duration of the actual bear market itself. This last bear market was the worst since the Great Depression, but it had one of the best and fastest recoveries in history, as shown in Table 1-7. Investors should realize that these long bear markets will occur again in the future, so a strategy to protect principal must be in place in advance to avoid this ravaging of principal.
PERCENT GAIN AFTER BEAR MARKET
The percentage gains after bear market bottoms have been substantial, as Table 1-7 illustrates. Rallies have been per sistent even during the bear market of the 1930s. The S&P 500 experienced its best bear performance in the first 12 months from the recent bear market lows since 1949. And the recovery from the March 2009 lows has been phenomenal, with the two-month advance more than doubling the average for that time frame.
SECULAR BULL AND BEAR MARKETS
Bull and bear markets occur over both short and long time frames. Table 1-8 shows two long-term (secular) bull and three long-term bear markets for the period 1929–2009. This table was prepared by
Dennis Tilley, director of research, Merriman, Inc. For the entire 81- year time frame, the S&P 500 Index had an average annual return of 9.1 per cent. But it was not all smooth sailing over that period. The secular bull markets from 1942 to 1965 and 1982 to 1999 produced average annual gains of 15.7 and 18.5 percent, respectively. But the three secular bear markets produced much lower annual average returns. So, as you can see, there can be long periods of time when the market is flat or down.
Even in secular bull markets, there are cyclic bear markets, where prices rally and falter, rally and falter, but overall no progress or negative progress is made. There are numerous oppor – tunities to make money, assuming that you have the ability and will ingness to follow the markets and use a tried-and-true market timing approach that works.
The question to ponder now is whether we have entered another secular bear market that could last until the year 2017. No one knows the answer. This is why it is important to have a viable investing approach. Buying and holding in a secular bear market is
not a money-making approach. And inflation always eats away at whatever returns you are able to obtain, although inflation has been minimal the last few years. After inflation, the two secular bear markets prior to 2000 had negative returns.
Michael Kahn, writing in the December 16, 2002, issue of Barron’s, said: “Tired of waiting for a clear trend in the stock mar – ket? Get used to it. If an emerging pattern continues, the major indexes could be in for 15 years of bouncing around. That’s right, 15 years. Since World War II, the market has seen an 18-year rally, fol lowed by an 18-year flat period, followed by another 18-year rally—the one ending in 2000. That means we could be about three years into the next 18-year flat spell.”
The stock market is not a place for amateur investors who think that they can sit back and rake in the profits, year after year, with little risk. As you just saw, secular bear markets follow secular bull markets. The stock market is a very risky place, where investors need to be on their toes or their feet will get burned. Long-term financial success in the stock market is difficult to attain, if not impossible, unless investors use a solid investing plan, develop strict entry and exit strategies, and have the psychological makeup to make tough decisions when conditions look the bleakest. Buyand- hold is an anachronism. As you learned in this chapter, bear markets occur often, take considerable time to come back to break even, and can result in significant financial loss and emotional distress. This is why investing in individual stocks, mutual funds, or ETFs at the wrong time can be deadly to your wealth.