Stock Market Talking Points {Part Two}

Today is part two 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.

2 "Stocks on average make you about 10% a year."

Stop right there. This is based on some past history -- stretching back to the 1800s -- and it's full of holes.

About three of those percentage points were only from inflation. The other 7% may not be reliable either. The data from the 19th century are suspect; the global picture from the 20th century is complex. Experts suggest 5% may be more typical. And stocks only produce average returns if you buy them at average valuations. If you buy them when they're expensive, you do a lot worse.

I believe the author is correct in his assessment. While there is pretty good data from the 20th century on the rate of return of equities, relying on data any earlier than that is suspect. There have been many studies trying to figure out what the true rate of investment return was for companies prior to 1900. Most come up with different conclusionsm, usually to support the argument of whatever side the author of said study is arguing. Each era is also different so trying to draw some conclusion using 19th century data in a 21st century world will not likely help most of today's investors retire wealthy.

Probably a better way to look at historical data is take a 10 or 20 year rolling average and seeing whether those rates of return are higher or lower than some historical average for the 20th century. Investors can play with these numbers if they want. We often use a series of historical averages between 6-10% to compare previous rolling periods. If the current period return is higher our historic range then it suggests a period of under performance is in order. The opposite when current period returns are comparative much lower can also be applied for suggestive comparisons.

Currently for example you take a 10 year rolling average of the S&P 500 {2000-2010, which is also one of the worst 10 year periods ever recorded} then the data suggests that the next 10 years should be a better period for stocks.

3 "Our economists are forecasting..."

Hold it. Ask your broker if the firm's economist predicted the most recent recession -- and if so, when. The record for economic forecasts is not impressive. Even into 2008 many economists were still denying that a recession was on the way. The usual shtick is to predict "a slowdown, but not a recession." That way they have an escape clause, no matter what happens. Warren Buffett once said forecasters made fortune tellers look good.

Economists look at past data to try and forecast future trends. The stock market is a forward looking mechanism that votes everyday with investor's money. Markets bottom months before the economy and stocks usually peak in a cycle when everything looks fine.  Economic data since it is generally backward looking does a poor job when trying to forecast future returns.

Link: Stock Market Myths

Tomorrow we'll publish part three!

*Long ETFs related to the S&P 500 in client and personal accounts.