The Great Stock Recovery - Or Not?

"You can fool all the people all the time if the advertising is right and the budget is big enough." - Joseph E. Levine

Let me start this blog by saying that I am not a perma-bear (a person that is constantly negative on the stock market), I am just giving you the best advice I can based on my overall economic outlook.  Let me also say that this blog or quote is not about Apple stock or its products both of which I believe are overly priced stocks and gadgets that have been hyped by an exceptionally brilliant salesman.

No, I am referring to the market which has just rallied more than 10 percent in less than two weeks.  Many are talking about this as the beginning of the next bull market but I would caution you to remain on the sidelines.  In dissecting the stock market movements that have occurred during the previous decades it is clear that the market has averaged returns north of 7 percent a year.  This number is often touted by unseasoned professionals and financial planners as the reason to invest in a portfolio of stocks.  The return is higher than those of the bond market or most other investments the argument goes, so it is imperative to hold stocks (and a large portion of them) in your portfolio.  Not only should you buy them but no matter what the outlook you should remain in stocks as you can never time the market and the average return will even out over the long-term.

My beef with this argument is that the long-term is often longer than any of us have left in our lifetimes.  This average return has been averaged over roughly 100 years!  I am sure I do not have that long left on this planet and if I do then my son will have his hands full in supporting me!  No, most of us have a horizon of 10 to 20 years at most, so I would argue that you need to look at returns over those periods of time.  Taking these parameters the landscape changes in an instant.  Stocks have not moved at all since 2000 and in fact are well below that peak and have provided a negative compound annual rate of return of (0.5) percent.  Going back another 10 years (1990 to 2000) and suddenly you are rewarded for being in stocks with compound annual returns of over 13 percent for that decade.  Taking the two decades together and your total return falls to just over 6 percent or below the general trend.

So buy stocks now and be rewarded over the next 10 years?  To answer that question we have to look at what drives stock returns.  Returns to stocks are highly correlated to the increased earnings that companies enjoy as the economy expands.  Looking back at the 1980s through to 2000 the US economy benefited from years of overspending by the US consumer whose savings rate dropped from 12 percent to 1 percent.  Furthermore household debt increased from 65 percent of disposable after tax income to 135 percent.  Added to this was low interest rates, easy money loans and many other exuberance's that were unsustainable.  It was just a matter of time until the party was over and it is now over.  These excesses are going to take a long time to unwind driving down economic growth and therefore company profits.  I expect that the current economic environment will last at least another five years if not a decade therefore I conclude that the stock market will produce returns close to zero or even negative returns during that time frame.  Assuming no return for the next decade takes the average return in the market for the 30 year period down to 3.85 percent.  Certainly not something to crow over.

I would argue that rather than risk your money in a volatile stock market that is producing no returns but which has the propensity to nose dive at a given notice that you should exit stocks for an extended period and start to realize that a return of three to four percent on your money is the new "normal".  At least for the next decade it is.  If you then factor in the real probability that there may be global deflation coming your real rate of return on an investment yielding 3 percent could be as high as 6 percent.  No-one would sniff at that now would they? (In my next blog I will look into the reasons that deflation is still an impending problem and how it will affect your investment outlook for years to come.)

In these poor economic times and until the global economy gives signs of stability I believe that you should exit stock positions and look to invest the proceeds in income bearing investments.  If you must own stocks then look to large cap dividend plays as these companies will be able to sustain an extended downturn far more safely than smaller companies.  Don't get me wrong, I believe that there will be plenty of companies that make a lot of money in this environment and innovators will succeed as always, but outside of these exceptions stocks are not a good place to be invested at present.  Furthermore I would argue that finding a safe return of 3 percent will be looked upon as an excellent investment in the coming years.