Alpha Power Investing Newsletter

February 25, 2010

Let's Get Real

Here's an investment quiz: What's the longest period of time when the S&P 500 stock index (not including dividends) showed no gain adjusted for inflation?

  1. 10 years
  2. 17 years
  3. 48 years
  4. None of the above

The correct answer is D, because the answer is 80 years. Yep, you read that right - 80 years without appreciation.

One of the best investment books ever written (I think) is Irrational Exuberance, by Dr. Robert Shiller, Professor of Economics and Finance at Yale University. Shiller's book was published in early 2000 and predicted a long period of low or even negative returns for the stock market. His prediction was based on the extremely high valuation of the market at that time - the highest valuation in U.S. history. On his website, Dr. Shiller maintains an inflation-adjusted price history for the S&P 500. It's a real myth-buster.

Based on today's price of about 1100, here are some inflation adjusted price points spanning the last 110 years:

* 1902: 220.17 (Jan)     1952: 196.43 (Jan)
  1921: 80.53 (Jan)     1962: 495.43 (Jan)
  1929: 312.84 (Jan)     1972: 540.80 (Jan)
  1932: 75.47 (June)   * 1982: 241.45 (Aug)
  1942: 122.40 (Jan)     1990: 495.04 (Jan)
            2001: 1817.35 (Jan)

* The real price of the S&P 500 in 1982 was only marginally different from its real price in 1902 - 80 years of no real appreciation.

A lot of investors think that the stock market is an appreciation machine over time, with a few interruptions here and there that are quickly recovered. The real story is obscured by nominal returns and reinvested dividends. Wealth is purchasing power, not nominal returns.

Since 2000, the S&P 500, with dividends reinvested, has lost 43% in purchasing power. As you can see, this is not that abnormal.

Recovering this loss will require a real gain of 80%. When the history books are written, this era may down as another one of those long multi-decade dry spells, like 1902 - 1921.

Looking at the market in inflation-adjusted terms, there have been three periods in the past 100 years when real appreciation has been significant: 1921 - 1929, 1945 - 1966, 1982 - 2000. The rest of the time the market gave back those gains or spent years treading water until stocks became bargains once more.

So where are we now?

Based on Dr. Shiller's method of valuation (the 10-year trailing price/earnings ratio), stocks are at the upper end of the valuation spectrum. According to Shiller, the stock market is valued at about the same level as it was in 1968, when the Dow peaked at 1000. The Dow didn't move above 1000 and stay there until late 1982.

What this means is that today's investor should view the market as a tactical instrument - not a long-term holding. Alpha's strategies are designed to succeed in just this kind of environment. You can review them in the Programs section of www.alphaim.net.

Sincerely,
Jerry Minton, Ph.D.
President



© 2010 Alpha Investment Management Inc.

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