Alpha Power Investing Newsletter

September 3, 2019

What 100 Years of Stock Market History Tells Us

While ours is an ever-changing world, history is often not only a great teacher but also a great source of perspective. This is true in all facets of life, including the stock market. Historically the stock market has swung from low to high and back again based on the state of the overall economy and the trend in corporate profits. This month we will take a look back at 100+ years of stock market history and see if there are any lessons that might apply today.

Figure 1 below displays 100+ years of stock market history using the Dow Jones Industrial Average.

From this chart we can say three things:

  1. In the long run the stock market goes up.
  2. There are significant declines along the way.
  3. The market can go sideways for long periods of time.

While #1 is good news for investors - as it can afford them the opportunity to make their money grow - #2 and #3 above can prove to be tremendous obstacles to long-term success. We will talk about large declines in a moment. But for now, consider the following fact - the Dow went sideways for:

  1. 22 years from 1927 to 1949
  2. 17 years from 1965 to 1982
  3. 13 years from 1999 to 2012

If nothing else, these long periods of no net price gain argue strongly against simply buying-and-holding an index fund, as the prospect of sitting in an investment for 13 years or more for no net gain is unacceptable.

Figure 2 displays the Shiller PE Ratio, which adjusts annual S&P 500 earnings by inflation and then uses a 10-year average of earnings as the divisor, with the S&P 500 Index as the numerator, to give a sense of whether the market is overvalued, undervalued or somewhere in between. High readings suggest the market is overvalued, while low readings suggest the market is undervalued.

It is essential to note that the Shiller PE Ratio (or any valuation measure), is NOT a timing tool. An undervalued reading is not necessarily a "buy" signal and an overvalued reading is not necessarily a "sell" signal. The Shiller PE Ratio is, instead, a "perspective" indicator that suggests when overall risk is high or low in the stock market. The best way to think of it is this way:

  • In the long run the stock market mostly moves based on economic conditions.
  • A recession is the economic equivalent of jumping out of a window.
  • Valuation (such as the Shiller PE) tells you what floor you are on when you jump.

In other words, if a recession occurs when the market is undervalued the declines are typically not so severe. On the other hand, if a recession occurs when the market is overvalued the declines can be near catastrophic to any investors' short-term - and possibly - long-term investment goals.

Figure 3 displays the Shiller PE Ratio with the percentage decline suffered by the Dow during several bear markets that started when the Shiller PE Ratio was considered overvalued.

As you can see in Figure 3:

  • The bear markets highlighted were quite painful and often devastating to investor's wealth.
  • The stock market should presently be considered "overvalued."

Once again, the fact that the market is overvalued on a long-term valuation basis is not necessarily a call to action. It simply alerts us to the potential that the next bear market - whenever it may come - will likely be "one of the painful kind."

Summary
There are always things to be concerned about that may upset the apple cart. Today those "things" include fears related to trade wars, an inverted yield curve and a slowdown in housing sales. Yet despite all of the present-day chatter by pundits trying to be the first one to "call" the next recession, the reality is that there are presently not a lot of obvious dark clouds impacting the U.S. economy. Nevertheless, the problem is that because valuation levels are presently high, overall downside risk is presently elevated. While the bull market could easily continue to push higher for some length of time, the point is that investors should:

  • Avoid the urge to get complacent.
  • Remind themselves that the market can (and does and will again) move sideways for long periods of time and that sharp declines almost invariably follow high valuation readings.
  • Consider strategies that can allow them to profit even if a bear market and/or a long period of low overall returns unfolds.

In our opinion, the ultimate goal of an investor should NOT be: a) to maximize return; nor, b) to minimize risk; but rather, c) to maximize the tradeoff between reward and risk. Alpha Investment Management incorporates time-tested seasonal trends into each of its investment strategies based on exhaustive research that indicates that this approach can offer patient, long-term investors the potential opportunity to achieve consistent long-term growth of equity with lower volatility (in terms of equity swings) than a simple buy-and-hold approach using a benchmark index fund.

Jay Kaeppel
Vice President and Director of Research
Alpha Investment Management, Inc.
877-229-9400
www.alphaim.net
info@alphaim.net

Disclosures and Disclaimers: The information contained herein does not constitute and should not be construed as investment advice, an offering of investment advisory services, or an offer to sell or a solicitation to buy any security. Before investing in any fund and/or strategy, investors should consider the investment objectives, risks, charges and expenses of the fund/strategy and its investment options.

The data used to construct the illustrations above was obtained from third-party sources. While Alpha believes the data to be reliable, no representation is made as to, and no responsibility, warranty or liability is accepted for the accuracy or completeness of such information.
 

Alpha Investment Management, Inc. is a SEC registered investment advisor located in the State of Ohio. Such registration does not imply a certain skill or training and no inference to the contrary should be made. The information and opinions expressed in this document are for informational purposes only. Any recommendation or opinion made in this document may not be suitable for all investors. The information contained herein does not constitute and should not be construed as investment advice, an offering of investment advisory services, or an offer to sell or a solicitation to buy any security.  

© 2019 Alpha Investment Management, Inc.

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