Stocks for Neither the Short Nor Long Run

04/14/2009 12:00 pm EST


Gary Shilling

Columnist, Forbes

Gary Shilling, editor of INSIGHT, explains why investors' faith in stocks has been shattered and why we shouldn't expect much from them in the next decade.

The recent 57% collapse in the Standard & Poor's 500 index to its most recent low on March 9th followed hard upon the 38% decline in the 2000-2002 bear market. The Nasdaq Composite index, which nosedived 78% in 2000-2002, recovered only 44% of that decline before falling another 55%.

No wonder that investors' faith in stocks has been shattered. The buy-and-hold strategy, which was validated by the earlier long, steadily rising market, doesn't work in severe bear markets and is being vigorously challenged.

The odds may be in your favor in the long run, but if you hit a streak of bad luck, your capital may be exhausted before that long run arrives. Or more likely, a severe bear market will scare you out at the bottom. Many investors bail out then, and don't reenter until the next bull market is well advanced.

Active managers are supposed to be superior in bear markets. Still, 58% of active US stock managers failed to beat their benchmarks last year, and only a few of the 42% who bested their benchmarks had positive returns.

As we've written many times, "On the way up, performance is relative but on the way down, it's absolute." No investor can be happy with a portfolio manager who beats his benchmark, but still loses money. Furthermore, in recoveries from bear markets, many active managers behaved just like individual investors and remained on the sidelines too long.

We've never understood US individual investors' fascination with stocks, almost to the exclusion of all other investment vehicles. Stock backers point to long run annual gains of about 10%, but neglect to note that about half of that came from dividends.

Stocks way, way underperformed Treasury bonds in the 1980s and 1990s in what was the longest and strongest stock bull market on record. The superiority of Treasuries has been even [greater] since then.

[If you invested] $100 in a 25-year zero-coupon Treasury bond at its yield high (and price low) in October 1981, and rolled it into another 25-year Treasury annually to maintain that 25-year maturity, on March 31, 2009, that $100 was worth $16,656 with a compound annual return of 20.4%. In contrast, $100 invested in the S&P 500 at its low in July 1982 was worth $1,502 last month for a 10.7% annual return, including dividend reinvestment. So, Treasuries outperformed stocks by 11.1 times!

Unfortunately, that rally is over. Our target of 3% yield on 30-year Treasuries, down from 14.7% in 1981, was exceeded at the end of 2008 when the yield fell to 2.6%.

In the next decade, we foresee much slower growth in GDP than in the 1980s and 1990s.  In this secular bear market, stock market average gains will probably be much lower, with cyclical bull markets shorter and weaker while bear markets are more frequent and deeper.

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