Baruch hasn’t stopped blogging. He’s just been busy at work. To be fair, there also hasn’t been that much he has wanted to write about.
That changes here! A recent and growing animus in the econoblogoverse to, of all things, equity markets, has woken him up. Baruch finds this fairly incredible. Equities, he is fairly convinced, are the asset class of the future. This anti-equities movement, led by jealous journalists and winking, cackling bond apologists with axes to grind, needs to be nipped in the bud, as it is dead wrong. The WSJ’s otherwise reasonable Brett Arends is Baruch’s immediate target among the evil-thinkers, for his (last week’s top read on Abnormal Returns) The Top 10 Stock Market Myths that Just Won’t Die. And that Felix Salmon is also guilty as sin in this, for many offences against shares committed over the past few years.
Myth 1: stocks don’t generally go up
Wronngggg! Try shorting for a living and see how long you last. I’ve tried it. It is *really* fricking hard. Actually this year my shorts have made me more money than my longs, but I am an investing genius, and you are probably not. To those bond apologists who claim that this “stocks for the long haul” stuff is bullshit, I urge you to actually count the number of 10 year periods since 1950 where stocks have not made you a net percentage gain. I can only see 1963-64 and 1999-2001 as periods with evident losses (check out the S&P log chart from 1950). So around 90% of the time in the past 50 years, stocks have made you money on a 10-year investment horizon.
It’s not like you lost lots of money when they did go down, either. At worst, if you had been unfortunate (or dumb) enough to invest in January 2000, by 2010 you had lost about 20%. You would have faced the same, a 20% loss, in 1964 to 1974. Your upside risk, however, has been pretty assymetric, and in most 10 year periods you would at least have doubled your money, with triples, quintuples and zilliontuples common in the 10 year periods after 1980. That’s from a 60-year sample, which admittedly doesn’t include much in the way of catastrophe, revolution and property confiscation that has occurred in the stock market histories of other countries. But still, equities look pretty good to me off this very basic analysis.
Clearly, just because in 90% of cases equities made you a positive 10 year return in the past is no guarantee it will continue in future periods. But I bet there were moaning minnies telling us stocks were dead at every point in this history. The onus has to be fairly put on the current stock-deniers to explain why they are right this time.
Myth 2: stocks and the economy are no longer linked
Brett Arends uses the Japanese example to illustrate this point: “since 1989 their economy has grown by more than a quarter, but the stock market is down more than three quarters”. He was probably well aware that this is a thoroughly exceptional example. This was number 4 in his top 10 list of “myths”, and I think he was already beginning to panic that he had 6 more to come up with still.
To be fair, the linkage between stocks and economies, while direct, is complicated. Companies’ share of GDP can increase or decrease while economies are booming or stagnating. Valuation is an extremely important filter. Extremes in the entry and exit point of when you actually invest can determines most of the result of the investment; Brett here chooses the very peak of the stockmarket and real estate bubble in Japan as his entry point for his trade. Not, I think you’ll agree, an exercise immune from sample size error.
The rest of the time, filters aside, stock prices are based on company earnings. When a company announces a better than expected quarter (nota bene, better than investors expected, not the sell side consensus), the stock tends to go up. In their massive, millionaire-creating stock ramps, Apple and Google and Microsoft all went up because we realised they were going to earn much more in period n+1 than we thought at period n.
Fact is, economies tend to grow, and in a country with stable population it is productivity gains, doing more with the same or less, which is responsible. In other words, innovation equals growth. The repository of innovation, the sharing of ideas and the investment to put them into practice is the private sector, in the vast R&D departments of major enterprises and fast moving startups. May I refer you to the cod Hayekian but still excellent work of fellow Collegiant Matt Ridley for a longer exposition of this. That’s what you buy when you buy equities, that’s what you incentivise when you ask for shares in an IPO. You are driving and partipating in economic growth. Economies grow, company earnings tend to go up, and shares tend to rise. Simple really. Don’t lose sight of the forest for the trees.
Myth 3. The Machines are in charge. The Humans should give up.
Algo-bots sort of rule. Machines dominate lots of daily flow, and make it weird. But they don’t determine the forward PE ratio of e.g. Cisco. We do, and by its own lights the reasoning behind stocks being where they are is sound — if we double-dip, CSCO and everyone else will see their earnings fall, and so stocks trade at lower PEs than their long-term growth track record implies they should. Consensus estimates, the denominator of the PE, do not include the possibility of another recession. The punters, who are not paid to be bullish, don’t trust the numbers and are partially pricing it in.
So we don’t need to blame the algos and high frequency traders for our long positions going wrong. Hedge fund dudes, market makers, and lots of people whose livelihood is exploiting the shorter term moves in the stock market, DO have potential grounds to complain. Their jobs have become harder because of the bots, whose job after all is to scalp the humans. But this is not a reason to give up on stock market mechanisms that still reward medium-term savvy investment decisions.
Listen: the markets are always hard. Its supposed to be like that. Oddly enough, rather than blaming themselves, people like to have someone else to pin it on when their investments go wrong. In the 1990s they used to blame daytraders for driving internet rubbish to great heights, then in the naughties the shadowy “Plunge Protection Team” was the scourge of the bears. These days the bots are the scapegoat. The bots will one day overreach — if they ever really “ran” the market they would very quickly stop making money; trying to scalp each other would not be a good idea. Relax, and learn to love the bots. Whatever bogeyman that replaces them may be much scarier.
Myth 4. Higher volatility = Sell your stocks. We are in a period of higher volatility
This is just SO VERY WRONG that Baruch has to bite his fist. Were it not the thesis behind Felix Salmon’s call to sell all stocks (backed up by some pointy-headed algebra) the midst of the sovereign debt bruhaha of not so very long ago, Baruch would merely have ignored it. To have Felix (Felix!) tell us this is like hearing someone you respect and admire tell you the moon landings were faked by the guy on the grassy knoll, that the US military invented AIDS and that people from Harvard Business School are capable of independent thought. You want to edge away, slowly.
Historically, higher volatility is actually the long investor’s friend. It is associated with stress, periods of fear and panic — in other words buying opportunities, not good points at which to sell. Similarly, low volatility is associated with periods of complacency and is often, but certainly not always, a good point to sell. It’s easy to act pro-cyclical. Buying “at the sound of cannons” is very hard when the cannons are actually going off. Selling is a much more natural reaction, and brings very quick relief. You can feel a very virtuous disgust at stocks, vow never to go near them again, and go and buy some 10 year T-bonds at a 2.4% yield.
Of course, this is a terrible mistake. All you have done is maximise your losses, and give up on the idea of ever making them back. No less an authority than Mrs Baruch, herself an accomplished investor, characterised selling at high volatilty and buying at low volatility a “catastrophic” idea when Baruch told her about it. In order to make money in equities you have to invoke the Costanza Doctrine, ie do The Opposite — the opposite of what you feel like doing, and the opposite of what everyone is telling you to do. The fact that very few people are actually clear-headed enough to do this is probably why equities as an asset class are increasingly unpopular.
Truth 1: everything else is screwed. If you need to invest, you will likely buy some stocks even if you don’t want to
The tragedy is, of course, that equities are the coming thing. No other asset class, at the moment, seems to have the same combination of great fundamentals and juicy valuation. Bonds while the 10-year yields you 3% in a period of heightened risk on sovereign solvency? Puh-leeze. Gold? Who the hell knows with the weirdos on either side of that trade. Commodities may be good, what do I know, but as an asset class they’re probably not suitable for more than 25% of your allocation. Real Estate? Maybe that’s not a bad idea either, but I refer to the answer I just gave on commodities. Also property tends to not be very liquid. Art? Wines? Antique cars? Be my guest. The dirty secret of alternative investments such as hedge funds and private equity is that most of them are disguised equity longs. Hedge funds generally feel much more comfortable being net owners of shares — Baruch has yet to see the multi-strat he works for go net short, for instance. Private equity needs healthy equity markets (and, if you ask me, naive ones) to make actual profits close to the otherwise fictional marks they carry on their books.
At the end of the day, however, it largely comes down to bonds versus stocks. You are going to be overweight stocks in the coming years. It might take some of you some time to actually bite the bullet, and you will do it at higher prices as a result, but you will do it. I look to no less an authority in this as the biggest, baddest bond investor in the world, PIMCO, who is getting into equities in a big way.
Right now, equity investors are being offered a win:don’t lose very much proposition. A double dip, the great fear of the equity markets, is at least partially priced in here, and the upside if we don’t double dip looks very good indeed. It’s a great moment for stocks.