Stock Market Talking Points {Part Three}

Today is part three of our Stock Market Talking points series. These posts are based on a Wall Street Journal article published a few weeks ago which we are featuring in serialized form. In the series the author, Brett Arends, takes what I will term 10 very common market talking points from both brokers and financial advisors and posts a rebuttal to each. My comments are in response to each section of the article.

4 "Investing in the stock market lets you participate in the growth of the economy."

Tell that to the Japanese. Since 1989 their economy has grown by more than a quarter, but the stock market is down more than three quarters. Or tell that to anyone who invested in Wall Street a decade ago. And such instances aren't as rare as you've been told. In 1969, the U.S. gross domestic product was about $1 trillion, and the Dow Jones Industrial Average was at about 1000. Thirteen years later, the U.S. economy had grown to $3.3 trillion. The Dow? About 1000.

The author's retort is the common response to the bullish longer term prognosticators. The author is essentially correct if one looks at static time periods. There have been three periods of time in since the 1920's when stocks have significantly underperformed. These are called secular bear markets These were periods roughly corresponding to 1929-1946, 1969-1983 and 2000 until now.

Each of these periods were marked by these factors.

1) A significant and longer term uninterrupted prior period of growth {think "Roaring 20's", "Post-War Boom" and "Technology Boom" monikers that labeled these times}.

2) An external shock to the economic system such as war or depression.

3) Subsequent government policies in response that stifled economic growth.

Most of the time the rebuttal to stocks as long term growth vehicles simply makes the assertion based on fact that investors who put money in the market for example in 1929, 1969 or 2000 had to wait years to get their money back. The other side, investors who put money to work in 1933, 1972 or perhaps as we may in the future see March of 2009, when market's bottomed made out pretty well.

The short is again as we said yesterday, look at rolling periods of investment.

5 "If you want to earn higher returns, you have to take more risk."

This must come as a surprise to Mr. Buffett, who prefers investing in boring companies and boring industries. Over the last quarter century, the FactSet Research utilities index has even outperformed the exciting, "risky" Nasdaq Composite index. The only way to earn higher returns is to buy stocks cheap in relation to their future cash flows. As for "risk," your broker probably thinks that's "volatility," which typically just means price ups and downs. But you and your Aunt Sally know that risk is really the possibility of losing principal.

Someday I'm going to do a whole series on risk. The subject is too complex and time consuming to simply cover in one post. I think the author is wrong here on several counts because there are more types of risk than losing principal. Investors putting money in bonds today for retirement for example risk not only principal but also the possibility of not having enough money for retirement as well as inflation risk. Buffett's investments are not exactly riskless either. Warren has had plenty of investments that have lost money for him. I think the difference between Buffett and many others is that he seems to have an investment plan which allows him to define his risk.

Tomorrow we'll post part four!

Link:  Stock Market Myths.

*Long ETFS related to the Dow Jones Industrial Average in certain client accounts.  Long ETFs related to the S&P 500 in client and personal accounts.