Alpha Power Investing Newsletter

June 16, 2010

Investment Propaganda

"Stocks are a great long-term investment."

"Stocks return about 10% a year over the long-term."

No doubt you've heard these words of conventional wisdom in many forms from many investment "gurus". Both statements are false and/or misleading.

What does "long-term" mean to you? Five years, ten years, twenty, thirty? What would make these statements false?

In this newsletter, I've decided to show you the work of Professor Robert Shiller of Yale University. Dr. Shiller is both a professor of finance and economics and is the author of "Irrational Exuberance", published in 2000. He is a proponent of the view that investors' appetite for risk is driven by a complex of forces (including propaganda) which are irrational. These forces produce stock market bubbles and crashes.

Part of his work includes mapping the real, inflation-adjusted price of the stock market. The chart below shows the real price of the S&P 500 historically since 1871.

As you can see, there have been long periods of stagnation and decline in the market, punctuated by equally long periods of real advancement. Because the price of the stock index is adjusted for inflation, it is easy to see the effects of high inflation on the market. These periods include the inflations of 1917-1920, 1942-1945 and 1968-1981.

The price index does not include dividends. A policy of continuously reinvesting dividends would flatten out the declining years, but would not convert them to "great investment" periods. It is also easy to see that someone who invested a lump sum in stocks at certain crucial times was doomed to negative real returns for decades.

The claim that the stock market has returned 10% a year over the long-term is based on the starting point of 1926 and the ending point of 2000. Stocks were still relatively cheap in 1926 and very expensive in 2000. Over the entire period inflation averaged 3.5% a year. The long-term calculation includes the biggest and longest bull market in history from 1981-2000. As the market has corrected some of the excesses of the 1990's, the long-term return is dropping. It's now 9.5%. Convert that to real terms and you get a 6% growth rate.

Over the most recent decade, the S&P 500 has delivered a real return of -3.5% annually including dividends (ending 3/31/10). Most investors have nothing to show for the past ten years since most mutual funds have tracked the general market. The only stock index to show a positive return has been the S&P MidCap 400 Index with a 3.2% real annual return. That index, however, only covers about 3% of the total stock market valuation.

A close look at stock market history provides us, I think, with a clear lesson - prudent investors should not buy into "long-term" stories of productive, real returns from the stock market. Instead, think of the market as a tool, like a wrench, to be used for a limited time, under well-defined conditions when the odds of robust gains are high.

That time is approaching as we draw closer to the mid-term elections. The third year of the presidential term has not been down (total return, Dow Industrials) since 1931 - with an average return three times greater than the other years of the election cycle. For a concise description of this phenomenon, go to our Home page at www.alphaim.net and click on The FormulaTM. For a longer, more detailed account, go to our Programs section and click on the E-System article "How to Exploit the Hidden Bull Market".

As always, I'd like to hear from you to discuss your investment situation.

Sincerely,
Jerry Minton, Ph.D.
President



© 2010 Alpha Investment Management Inc.

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