Wrong message at wrong time can come back to haunt the trusting investors

Investors have been told over and over again that the best strategy is to buy equities and hold them for the long term.

That mantra-like advice was repeated throughout the 1990s when the stock market craze was at its peak.

However, that was the wrong message, delivered at precisely the wrong time.

Over the past 10 years, equities have been poor or disastrous performers, depending what time interval was selected. In the world’s major markets, stocks have declined by just under 80 per cent, while treasury bonds provided a return of nearly 95 per cent over the same time frame.

That seems illogical as bondholders have first claim on the corporate sector’s cash flow – and shareholders are entitled to the rest, assuming of course, that profits keep growing.

Investors and speculators jumped into the stock market seeking high returns, and that pushed equity prices to sky-high peaks.

The ratio of prices to earnings rose in the United States by one-third, above the absurd levels of the 1929 peak.

That pattern was duplicated in the U.S. housing market, where many luminaries said house prices would never fall, but at worst, they would level off for a few years.

Now some forecasters are claiming that because the stock market has performed so badly over the past decade, they are certain to do well over the next few years, perhaps even compensating for those lost 10 years.

That same argument was applied to Japan, but there the weak stock market is in its third decade of a bear market.

The U.S. stock market never reached the incredible levels prevailing in Japan, but still it is selling at nearly 20 times current earnings, far above the historical average of 15 times earnings.

The implication of that high valuation is that speculators infer that boom conditions are in the offing, while far more likely, is some desultory growth – or even another recession.

Too many are assuming a strong recovery in the economy and corporate profits. Yet as the effects of various government stimulus packages wear off, the outlook is far from positive. Government efforts to keep interest rates low reveal the central banks’ uncertainty about the economy.

That, in turn, is pushing investors and speculators into a search for better returns, fueling again the over-valuation in share prices.

Like a cat chasing its tail, all this confirms that holding equities over the long term is not a reliable guide to good results.

Too many have absorbed the wrong message to their own investment peril.

 

Bruce Whitestone

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