Smarter Than the Street: Invest and Make Money in Any Market [NOOK Book]

SMARTER THAN THE STREET

INVEST AND MAKE MONEY IN ANY MARKET

The McGraw-Hill Companies, Inc.

Excerpt

THE LOST GENERATION OF INVESTORS

The two major market meltdowns of the last decade have created a new phenomenon that I call the "lost generation of investors." When I use the phrase lost generation, I mean the people who left the market between 2000 and 2009 and will not be coming back anytime soon as a result of their experiences during that very difficult period. I will use the phrase lost decade the way the Wall Street Journal does, to signify the period from 2000 to 2009, in which markets went nowhere. During the lost decade, millions of investors left the stock market and have never come back. Both of these phenomena occurred chiefly as a result of the two market disasters of the first decade of the 2000s, which some have called the "zeroes."

The first market debacle—the bursting of the dot-com bubble—started in 2000 and caused the Nasdaq to crumble from a high of over 5,000 in the first quarter of 2000 to a low of about 1,200 by late 2002. Since major market crashes don't happen very often, after this collapse, most investors thought that all was well with the markets and drove the Dow to top 14,000 in 2007 (while the Nasdaq has never come close to approaching 5,000 again).

During the lost decade, millions of investors left the stock market and have never come back.

Let's look at the year-by-year performance of the stock market for the decade 2000–2009 (see Figure 1-1). Please note that all the stock charts in the book use month end numbers. They may not look exactly like the charts you may see on other Web sites, which are likely more volatile because they use daily closing numbers. These percentages represent annual actual returns of the S&P 500:

As we contemplate the lost generation of investors, we will widen our analysis to include larger and larger segments of time so that we can see how the overall markets performed over the long haul. However, before we widen our lens, let's take a closer look at what the returns of the last decade tell us.

• First, we had a horrible start to the 2000s, with three down years in a row and each loss greater than that of the year before. That is uncharacteristic of the U.S. stock market. Since 1973, for example, only one out of every four years has been a down year. Of course, if we look at the entire decade, we actually had more up years than down ones, by a margin of six to four. But it is, of course, the magnitude of the gains and losses that counts.

• The horrific 37 percent loss of 2008 virtually wiped out the combined gains of the previous four years. That was the year of the subprime mortgage mess, and it blindsided investors. The stock market had already had its worst days in 2000–2002, most investors thought, so surely it was not going to crash again. Yet the subprime mortgage mess caused a liquidity crisis that had many experts talking depression. The events of the 1930s were at our doorsteps again, many people believed, thanks to the huge housing bubble that burst in 2008. That bubble and the ensuing liquidity crisis drove the Dow Jones Industrial Average from its high of 14,164 in 2007 to 6,547 in March of 2009.

• A $10,000 investment in the S&P 500 at the beginning of the decade would have left you with just over $9,000 at the end of the decade. That makes the U.S. stock market the worst performing of all asset classes for the decade, worse than cash, bonds, the money market, or real estate. This negative return unnerved many investors, leaving psychological scars that we will explore in depth later in this chapter.

We also know that investors bailed out of the stock market in a big way in 2009. In fact, we now know that more than $53 billion was taken out of the stock market in 2009 by jittery investors who could not wait to get out, and 2010 started off the same way. In early March, $4.6 billion had been taken out of U.S. stock mutual funds in the first quarter of 2010, according to the Investment Company Institute (and that figure did not include ETFs, or exchange- traded funds). And if all of that is not enough to convince you of how unpopular the stock market has become, consider this: In the first nine weeks or so of 2010, world equity funds had absorbed a little less than $14 billion, while bond funds were more than four times as popular, taking in more than $56 billion. This is proof positive that investors are willing to settle for the anemic returns on bond funds rather than risk their hard-earned capital in the equity and mutual fund markets. This trend of leaving the market was sparked by what happened in the last three months of 2008. During that period, the Fed reported that U.S. households lost 9 percent of their wealth, the most ever recorded for a three-month period.

A Brief Glimpse of Historical Stock Market Returns

To understand the lost generation in context, we need to understand how the equity markets have performed over time and what most investors expect from their investment in the U.S. stock market. That is, what are the assumptions held by most "retail" investors (the 100 million individual U.S. investors with some stock market exposure), and where do these assumptions come from?

We know that there have been several watershed books that have had a major influence on the psyches of millions of investors. One such book, which many now consider a classic, is Jeremy Siegel's Stocks for the Long Run. First published in 1994, it contains a plethora of information on the U.S. stock market dating all the way back to 1802, when it first began trading.

Siegel explains that a single dollar invested in the U.S. stock market in 1802 would have been worth $12.7 million by the end of 2006 (assuming that one reinvested all interest, dividends, and capital gains). That's a remarkable number to ponder. Siegel tells us that the U.S. stock market has averaged a 7 percent gain each year over those more than 200 years, and 10 percent when adjusted for inflation. Siegel's book has sold hundreds of thousands of copies over the years, and it has become a favorite tool of the great Wall Street marketing machine (in early editions, tens of thousands of copies of the book were purchased by brokerage houses). It is the poster child for buy-and-hold investing, a phenomenon that was held as gospel prior to the lost generation phenomenon described in this chapter (there will be more on buy-and-hold investing in Chapter 3).

Bear Markets of the Last Half-Century

There has been some great research done on the bear markets of the last 50 years or so. Examining the percentage and length of the declines tells us quite a bit about the financial markets. Since 1957, there have been 10 bear markets in the United States. A bear market is defined as a loss of 20 percent or more of the S&P 500. Table 1-1 gives a list of all 10, along with the years in which they began and ended.

Now let's turn the tables and take a look at the bull markets of the last half-century (see Table 1-2).

It is worth mentioning that there are several ways to slice up or synthesize the same information. For example, if you look at these bear and bull market tables, you will note that in some years, such as 1966, 1974, and 2002, we had both bear and bull markets either beginning or ending in the same calendar year. This reality reveals the complexity of attempting to time markets. Employing the definition of a 20 percent move as an indicator of a bull or bear market, we see bull markets that exist within larger bear markets and bear markets that exist within larger bull markets. The most notew
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Excerpted from SMARTER THAN THE STREET by GARY KAMINSKY. Copyright © 2011 by Gary Kaminsky. Excerpted by permission of The McGraw-Hill Companies, Inc..
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