Staying Aboard The Gravy Train

January 2, 2014 Current Commentary Comments Off
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I have been writing professionally, in one form or another, for just about 40 years. Sometimes I come across some long-ago pearl that now makes me wince, but once in a while the opposite happens: I rediscover something I can wave in front of my kids while proclaiming, “See – you should listen to your father!”

My most recent I-told-you-so moment is courtesy of my colleague Ben Sullivan. Ben was working on a newsletter article about investing in the wake of a big stock market run-up when he unearthed a piece I wrote on exactly this point. It appeared in Sentinel, our firm’s newsletter, in January 1997. But after the powerful rally in 2013 that carried the Standard & Poor’s 500 Index up about 30 percent to new record highs, it speaks to questions that are on a lot of people’s minds today.

You can find the entire article on our website, but the timeliest part is right at the top. And because I love saying “I told you so” (why deny the obvious?), here it is again:

When the stock market comes off a very strong year, investors naturally worry that the gravy train is about to be sidetracked. It was no surprise when The Wall Street Journal year-end review of mutual funds cautioned that “This year, many fund managers say, the pessimists could be right and the markets could take a dive.”

That article was published last year, on January 5, 1996. The U.S. stock market went on to a second consecutive banner year, with the Standard & Poor’s 500 index up more than 20% on top of 1995’s 34% advance.

So much for taking a dive. This goes to show not the ignorance of the pundits, which remains debatable, but the futility of trying to time the markets. Yet investors from the swashbuckling fund manager to the toe-in-the-water novice persist in this most counterproductive behavior.

I can tell you with 100% certainty that the market will crash, but I can’t tell you when. Nobody else knows, either. What we know is that while the market has advanced at a healthy clip for the past century, it has been an advance punctuated by shocks, stalls and slowdowns, some of which last for years. Meanwhile, the market’s upward moves have often come in brief, sharp rallies that leave behind investors who are prone to be “defensive” when things look bad. The successful investor must accept the bad times with the good.

Remember Jeff Vinik, former manager of Fidelity’s Magellan Fund? Many people believe he was pushed out of that job for betting on bonds in the first months of 1996, which turned out to be a bad time for bonds and a good time for stocks. To my mind, however, Vinik’s sin – if any – was not that he picked a bad time to invest in bonds, but that he invested in bonds at all, given that his fund’s owners thought they were paying him to invest in stocks. Maybe he owed it to his shareholders to deliver stock performance even if stocks performed like a dog.

Back in 1985 another money manager decided that stocks just could not keep climbing as they had since the bull market began in 1982. A couple of my clients stuck with this manager as he missed the rise of 1986-87, the October 1987 crash that briefly made him look good, and the recovery from that crash which segued into the recent record market highs. The Dow has about tripled since this manager turned bearish, and as far as I know he is still waiting for Armageddon. Someday he may be right, but at what cost?

The route to success for small investors is neither difficult to understand nor hard to travel. First, you have to know your financial goals and your personal willingness to withstand market downturns without selling. Next, you have to allocate your investment portfolio among stocks, bonds, cash and perhaps other investments in a way that is consistent with your goals and risk tolerance. Most important, you should be diversified across companies, industries, countries and investment-selection philosophies.

Then all you have to do is wait. If markets perform the way they have performed for many years, you will do quite well.

For the record, the S&P 500 went on to have yet another banner year in 1997, returning more than 33 percent, including dividends. It performed almost as well in 1998 and 1999, to cap a remarkable five-year run amid the dot-com explosion (though it did not reach the spectacular peak, or later suffer the same intense fall, of the tech-oriented NASDAQ benchmark). The S&P 500 hit its all-time high in March 2000 before the crash of which I was “100% certain” occurred.

Then came the rebound accompanying last decade’s housing boom, followed by an even more spectacular crash and, now, new record highs amid an accelerating recovery. As I said back in 1997, “The successful investor must accept the bad times with the good.”

Once again, I am 100 percent certain that another crash will occur, and once again, I can’t tell you when. I could make a case for it to happen sooner than later, with rising interest rates, political gridlock, geopolitical tensions and fiscal imbalances high on the list of potential triggers. On the other hand, not everything that can go wrong always does. In fact, it usually doesn’t, and even things that go wrong tend to get put right sooner or later. Less than two years ago, people predicted the imminent death of the euro currency; lately it has been trading at multi-year highs.

Don’t put next month’s rent money, or next year’s college tuition, in the stock market – not unless you have other resources that would allow you to ride out a multi-year downturn if it happens to come along in the meantime. But unless you plan to land a big sports or movie contract, win the lottery or launch a hot startup, don’t think you can build a substantial nest egg over the long term without consistently participating in equities. Wealth is accrued by people who amass things of lasting value, even if that value tends to fluctuate in the short term.

Pretty much everything I wrote in that 1997 article is still true today, and anyone who followed my advice at the time is probably pretty pleased with the results. So I will repeat what I said before: Just because you have been riding the gravy train these last few years does not mean you should hop off now. There is a lot of track ahead, and history shows that, ultimately, the destination is worth putting up with the bumps along the way.


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