Stocks for the long run

One of the major developments within the financial industry over the last half-decade or so has been the ascendance of passive investing as a discipline.   The reasons for this are not hard to discern; the performance of active managers as a class has lagged major benchmarks and the fee schedules are, by and large, unappealing.  In many cases, managers who appear to possess a genuine edge (e.g., Renaissance Technologies) are either closed to new investors or only manage proprietary capital.   (And no, humble pie does not constitute a genuine edge.)

Amidst all the tutting from the proponents of passive buy and hold investing, however, there seems to have emerged a smugness that evninces itself every time the SPX flirts with a new all time high, as it has since the election.   The chart below is a few years old but still gets trotted out with regularity when equities are at their peak, usually as a justification as to why you should never sell (or why it was a mistake to have sold your SPY or Vanguard 500 holdings.)


While it is certainly true that the long term trend for equity prices has been higher, it is equally the case that there is no guarantee, as seems implicit in the commentary of the passive investing fetishistas, that they will go up during one's investing lifetime.  There have been several occasions when stocks have delivered no returns over periods of 30 or more years.  It's all well and good to look at the chart and say "well, ya should have been long", but the higher the valuations are today, the lower the expected return is tomorrow.  As the small print promises, past performance is no guarantee of future returns.

Of course, virtually all of the praise for buy and hold passivity that Macro Man has encountered has come from the United States.   A healthy dose of this has no doubt been warranted, given the ability of the finance industry to separate the consumer of retail financial products from his money.   That being said, the belief that buy and hold is some sort of optimal strategy likely rests on a foundation of American exceptionalism.  After all, how do you think Greek investors feel about a passive buy and hold strategy?

OK, Greece is just small country.  What about the Eurozone as a whole?   Let's talk when the total return of the Eurostoxx eclipses its 2000 highs.


One wonders how much traction the buy and hold message would have here.  Still, despite the sovereign crisis the Eurostoxx has been the land of milk and honey compared to Japan, where total returns are at levels first reached nearly 30 years ago.


So sure, by all means if you don't have a view, take your equity risk with index products and be happy with the market return.  (No, seriously!)  But just remember that the long run on a 400 year chart is a lot different than the long run for a 40 year old guy looking to put a few kids through college and have a few nickels left over for retirement.  Valuations matter, there's no guaranteed pot of gold at the end of the Vanguard 500 rainbow, and while over-trading is a cardinal investment sin, so too is willfully sticking your head in the sand and dismissing the need for thought.

Previous
Next Post »

27 comments

Click here for comments
Celeriac1972
admin
November 29, 2016 at 9:02 AM ×

Thank you for this MM. You make your point well as always.

The mantra of the passive guys is that most active managers fail to beat indices. That most passive managers also fail to beat indices is conveniently overlooked.

The meaningful comparison (for the real-world investors that you reference) is between active and passive funds within the same sector, preferably after adjusting for risk. When I last commissioned a proper study on this - the work required is detailed and time consuming - the data showed that passive funds were not "the better choice" that they popularly assumed to be. Sadly I was working for a house that also had a passive business, so the study was carefully smothered with an old blanket... Now I have a little more time on my hands and fewer restrictions I may revisit this.

Reply
avatar
checkmate
admin
November 29, 2016 at 10:06 AM ×

You're only wrong on a technicality. The same ethos as taken root in the UK. To validate that you only have to look at a shortlist of the most popular equity funds. They are all run by managers who state BTH for the longer term is the fund ethos. It's understandable looking back at the last 15 years or so.
From memory I can't recall whether it is two or three periods of multiple decades which resulted in no positive return ,but anyway the concept is right in that the period of null returns out-reaches the investment life of many people. I'd also make the point those periods have never been tested within the investment careers of virtually all of todays managers including Buffett. Although notably Buffett closed a fund years back during the latter stages of such a period.
This brings me back to my mantra of having an anchor based upon fundamental value because without something like that to hold onto I don't know how one is supposed to decide on positioning for the longer term.
Personally, I don't give a s..t about the odd guy popping up to tell me I should be max long risk because I have along way to look back where I can see these same people passing me going in the opposite direction wailing about their P&L. Just because you appear to be right doesn't mean you stay right ,but typically they are never around to talk when that happens.

Reply
avatar
Hotairmail
admin
November 29, 2016 at 12:27 PM ×

I was going to make a similar comment Celeriac 1972.

You rightly point out that the typical analysis between passive and active funds is fundamentally flawed if one is just looking at absolute returns over time. Clearly risk, time in market, etc. are key considerations.

But apart from that, and coming back to Macroman's point, as an investor/trader I'm really not looking to optimise my returns. I'm looking at the best possible chances of a positive return in my lifetime/investing time horizon. I am quite prepared to accept a lower return, even take on more risk for short periods, or go short, if it means I can get what I want in a meaningful period. I don't want to see any negative years at all for instance. I don't want any losses at all, but I know that is unreasonable. Attempting for a positive year, year in year out is not.

Reply
avatar
November 29, 2016 at 1:53 PM ×

It may be easier to actively manage stock selection within sectors, with a passive view taken to sector weights. This takes a long long view though, to truly let the best companies shine.

More on the equity take, rethinking Trump implications, short term, and long term

http://crackerjackfinance.com/2016/11/turkey-day-highs/

Reply
avatar
washedup
admin
November 29, 2016 at 2:32 PM ×

I don't know how many of you play poker, but the best way to imagine this is to think of the passive funds (and frankly even long only actives) are being in a poker game where they own 98% of the total number of chips for historic (performance) and institutional reasons, and their only strategy is to be almost completely all in regardless of their hole cards or the flop. Clearly with that kind of ammo, no else can even bet against them, so they keep stealing blinds year after year, and if anything CBs assure them their chips will be topped up were anything untoward to happen, however remote that probability. The catch is that for all their firepower, they are known to run away from the table in urine stained pants if they lose even 20% of their chips, so it can be safely assumed they have the risk tolerance of cardigan knitting octogenarian grandmothers while participating (funnily, unbeknownst to them) in what is a gunfight at the OK Corral when seen over a multi-decadal horizon.

Now this sets up a highly autocorrelated dynamic to the upside for really really long periods - I have my thoughts on what comes along to disturb this equilibrium once in a while, or perhaps one day in our lives even quasi permanently, but suffice it to say the only question is timing and not inevitability - astute readers are welcome to share their thoughts and disagreements of course.

Reply
avatar
abee crombie
admin
November 29, 2016 at 4:08 PM ×

Nice post MM, a topic near and dear to me. 1) Lets not forget that US equities , for the past 15 years were not an amazing investment, really up until 2013. The valuation levels of the 1990's had to be worked off. You would have made more money in bonds.

2) We could probably put a similar chart up with London/Sydney/Vancouver house prices. So monetary debasement probably has something to do with it as well

3) Stock prices are a function of earnings and valuation. EU stocks have sucked for the past 20 years bc they cant grow earnings, whereas the AAPL's and JNJ's of the world have. The stock market is just a collection of stocks. EU companies that have grown earnings have provided strong returns (Loreal, Inditex etc) and US companies that havent grown earnings are treading water too (Intel, CSCO, Banks etc). The main difference in US vs World indexes over the past several years, while some may believe is the PPT/Fed, has been juggernaut tech earnings. EU /JP dont have anything close. Chinese internet are similar but not there yet.

4) washed, stock prices will go down in the US and else where when earnings start to miss in a big way and prices are too expensive. We are expensive, but waiting for earnings to miss. We had the chance earlier this year but bears couldnt take over, and big tech was still beating like crazy

Reply
avatar
Anonymous
admin
November 29, 2016 at 4:17 PM ×

With spoos pushing back to all time highs, Nico is once again being taken to the poor-house.

If you'd like to lose 90% of the time, and face unlimited losses, you too would be advised to follow his strategy of shorting stocks in the face of endless central bank bids and carry trade buying.

Reply
avatar
Mr. T
admin
November 29, 2016 at 5:35 PM ×

In case anyone here hasn't seen this, its great: The Paradox Of Active Management.

Regarding positioning, I'm as flat as a pancake. It's been a solid year, I have no intention of blowing it. This whole rally smells like bullshit to me, but I'm mindful that a lot of that is probably me projecting my feelings onto the market too much. I believe lots of other people are doing that too, with different baselines. My inclination is LB is right - this is yet another pop of growth optimism that we have seen so many times, but the underlying long-trend headwinds that have capped growth are still solidly in place. A period of higher inflation, bigger deficits, and policy confusion does not seem like a recipe for higher stock prices, nor bond prices. Defense.

Reply
avatar
Leftback
admin
November 29, 2016 at 5:48 PM ×

I see that bear-baiting anons are back. This usually coincides with high levels of bullish sentiment among Johnny Retail and his friends, as revealed by AAII Bulls (which is very high here).

Crude isn't buying the Trump Reflation Trade, and the long bond seems to be taking its cue from oil prices. If OPEC doesn't make a deal and US jobs aren't radioactive, the Risk On longs (and that now includes fans of Bucky) are in trouble.

For those of a technical disposition, the last week of price action in US fixed income has been quite instructive. Similar signs of decreased selling pressure are visible in charts for gold and GDX.

Reply
avatar
Anonymous
admin
November 29, 2016 at 6:43 PM ×

On the other hand, if you just kept buying stocks through thick and thin, on monthly basis, what would the returns look like? And compared to other asset classes?

I think it's easy to say stay out of market when it's so obviously expensive historically, until you realize it's still probably the highest return you're going to get anywhere.

The situation is absurd, but macro level things are slowly improving. I think this is what things would have looked like in the 1940s without fiscal war stimulus and investment.

Reply
avatar
Nico G
admin
November 29, 2016 at 7:34 PM ×

anon 4:17

where were you on Election night's Globex limit down? probably asleep after watching too much porn and playing too much fantasy football. i was awake, and covered 160 lots at 2030.8 average - the execution was so superb (and yes, lucky) that i do not mind putting them to work 150 points above, that it $1.2m repositioning fuck you very much

one day when you are old enough you will choose a name for yourself, and give me an email, and i will send you trade confirmations, so we can debate facts. Until then you shut up and let the big boys play ok? If you need money to start trading, ring me up, i have never funded a troll and would like to help you in 2017

Reply
avatar
Leftback
admin
November 29, 2016 at 7:34 PM ×

Macro level things are improving. This was certainly true for a year or two during QE1 and 2. Not really sure if it is true now.

The 1929 crash was followed by a long slow recovery and then the 1937 bear market came along after monetary tightening. You can view the stronger dollar following the end of US QE4 as a form of monetary tightening, if you like. We are overdue for an echo bear market, now that there are signs of overheating in many markets, e.g. US housing and small cap equities. Not saying that this is imminent, but it will catch up with us in the next 18 months or so.

Reply
avatar
Nico G
admin
November 29, 2016 at 8:03 PM ×

i want to second that LB - stronger dollar plus Libor going from 1 to 1.6% in one year is more blues than party music

Reply
avatar
Leftback
admin
November 29, 2016 at 8:27 PM ×

Crude is very weak as hope fades for an OPEC deal, and the dollar is bleeding down along with it. Say goodbye to the inverse correlation between DXY and WTI, this is what happens when you are a major oil producing nation!! The USD is now something of a "risk-on" commodity currency (like GBP) and the deflation/slow growth trade du jour is now long EURUSD or JPYUSD.

Gold seems to be maintaining its traditional status as the "anti-dollar", though. CNY is notably firmer than it was last week after reaching its lows on Thursday, as Chinese yields have backed up a bit, especially today. Don't rule out a bit of an upside move in CNY if China reports some decent numbers this week.

Mr Bond is feeling his oats today, perhaps the smart money smells a week of weaker US economic data?

Reply
avatar
Anonymous
admin
November 29, 2016 at 8:35 PM ×

Bloomberg just posted "The Man Who Invented Libor" ... the Greek banker Minos Zombanakis ... complete with a nice black and white portrait:

https://www.bloomberg.com/news/features/2016-11-29/the-man-who-invented-libor-iw3fpmed

Perhaps a distant relative of Nico's! :)

Reply
avatar
Anonymous
admin
November 29, 2016 at 8:36 PM ×

It's Dec 2015 all over again:

No Opec deal.
ECB underwhelm.
FED raise.

plus Italian & Austrian stuff Sunday.

And, you never know what Trump might tweet next.

Reply
avatar
johno
admin
November 29, 2016 at 8:39 PM ×

Started shorting USD yesterday, against TRY. Today against JPY. First is a bet 11% 5-year yields support the current as seen in the past. Also looks very cheap on my model. Yen looks cheap too -- more a bet that the US bond selloff has run out of steam. Looking at the 5Y UST yield, it'll be clear at levels not too far from here whether I'm wrong about rates. We'll see .. I haven't been in sync with the market of late.

Separate, yet related, I haven't seen much commentary here about the "eurodollar shortage" situation. Seen in the divergence between LIBOR (eurodollar market's rate) and Fed Funds (domestic dollar's rate). Anyone especially clued up on the topic? I'm trying to get my head around the connection between foreign insurance/pensions forced into US bonds by QE, the banks that provide provide xccy swaps to them and lent USD to EM corporates.

Reply
avatar
Skr
admin
November 29, 2016 at 10:13 PM ×

Anon 8:36

Yep, a lot of distractions to the key macro drivers since last year...

“Come in close. Closer. Because the more you think you see, the easier it’ll be to fool you. Because what is seeing? You’re looking, but what you’re really doing is filtering, interpreting, searching for meaning. My job? To take that most of gifts you give me, your attention, and use it against you.”

Reply
avatar
Anonymous
admin
November 29, 2016 at 10:30 PM ×

In 18 months anything is possible I guess. 3 months ago I thought Clinton and dems would win with landslide...

My best guess is that asset prices will do worse than the real economy in any case. Gravity is calling...maybe it'll be like in the 70s...

My investment strategy for 10 year horizon is go long 25% Tesla, 75% Berkshire. That's it. So simple it's silly. You got your inflation protection and stupid lopsided upside potential.

Reply
avatar
McAttack77
admin
November 30, 2016 at 12:25 AM ×

First time poster here, long time lurker. I gotta say I really admire your posts (among others) and enjoy the insight you provide. I'm short Spooz my self and just keep layering up via selling out of the money calls. This charade will eventually end, or at a minimum take a breather at some point. To all you guys who post your ideas and viewpoints they are much appreciated. Ignore the naysayers and keep the positive discussions going. Keep it small and live to fight another day. Good luck out there.

Reply
avatar
Nico G
admin
November 30, 2016 at 12:43 AM ×

you'd commit a quarter of your capital on one man's shoulders - what if Musk gets hit by a solar truck?

for the immediate term we have:

Italian referendum next week end + the Austrian joke

China increased capital control amid weakening currency + weak oil price (remember both were market obsessions in Jan/February)

USD crunch to come at EM universe

rates up on US 20 trillion debt

so far it is eerie to see strong US equity tarnish what otherwise was a perfect recipe for a shitty equity winter

Reply
avatar
Anonymous
admin
November 30, 2016 at 3:33 AM ×

Nico - "italian referndum next week end + THE AUSTRIAN JOKE" - LOL!! i almost spilled my beer... love you man.

Reply
avatar
SRX
admin
November 30, 2016 at 3:50 AM ×

You should post a graph of holdings of shares trading in Shanghai before the communist revolution.

Reply
avatar
Anonymous
admin
November 30, 2016 at 8:52 AM ×

Nico G: Statistically, I'm willing to take that bet with Musk. Besides, it's not just him. He has amassed ridiculous amounts of human capital and social capital in his companies and that's the moat I'm paying for as an investor.

Reply
avatar
Anonymous
admin
November 30, 2016 at 9:04 AM ×

So there's no way that some crazy new president of the US could say redirect renewable energy funding to something like coal? All while rates go up.

Reply
avatar
Anonymous
admin
November 30, 2016 at 3:27 PM ×

All but irrelevant to Tesla. Good for BRK.

Reply
avatar
Eric
admin
November 30, 2016 at 3:54 PM ×

Investing in index funds doesn't mean 100% in your home country, large cap portfolio. A total strawman that active managers and market timers cling to to try buy a few extra minutes before their boat sinks completely.

Let's start with Japan: sure, sincee 1989, the MSCI Japan Large Cap Index did -0.4% a year. The Japan Value Index, however, did +7.5% a year. US Large Value stocks over this period? +11.5%. Emerging Market indexes did well, global small cap stock indexes did well, etc. The lesson here? Index...but diversify.

Next, let's look at Europe since 2000. The Europe Large Cap Index is only +3.9% a year, but a Europe Small Value Index is +9.6%, US Small Value stocks are +12.6% a year, an index of Asia/Pacific Small Cap Value stocks is +11.3%. The lesson here? Index...but diversify.

What's the alternative? Stock picking? Please. Hiring an active manager? C'mon, 90% can't beat their style adjusted benchmark and those that do don't repeat. Tactical allocation? A sure way to get 20/80 returns with 80/20 risk from bad timing and flightly investor flows. Overweight bonds? Good luck getting a real return out of those.

Clearly, when you deconstruct the premise of this article, you see it's sadly incomplete and without merit, much like other anti-stock, straw-man arguements floating around the web.

Reply
avatar