“Is the recovery for real?” – Economic Perspectives June 1, 2010
“Is the recovery for real?”
Bryan Hankla CFP© and I were in Chicago for the NAPFA National 2010 Annual Conference during the third week of May. Continuing education credits in the stringent array of topics required by National Association of Personal Financial Advisors is important for us. This time the selection was better than usual for retirement, tax, estate planning, insurance and financial counseling. I arrived early to make a social media presentation for a study group meeting before the conference. From that, it seems I was in many informal discussions on the latest in marketing. Given the market volatility of the last few weeks, I think most people from outside our profession would be surprised how remarkably calm the attendees were on investment issues. Most of my old friends have seen so many volatile periods; we seem to feel it is a normal part of life, other than counseling to mitigate our clients’ stresses.
As always, we had excellent speakers on economics, finance and investments. This time there were two “big names” from investment management. John Rogers of Ariel Investments spoke on “The Importance of Diversity in the Financial Services Industry,” which was primarily about issues in our industry connecting with clients. Chris Davis’s topic is probably more interesting for the public these days – “Is the Recovery for Real?” I should say Chris Davis is the third generation of a family that has been managing stock investments since the 1940’s. Their investment philosophy has been consistent through all these years.
Resource Advisory Services has used Selected American Fund since before Davis Advisors assumed management in the 1990’s. The consistency they demonstrate and returns it produced through the last ten years (1.93% versus -0.19% for the S&P) provide the credibility we need from mutual funds. Yes, Selected American had a positive return during the “lost decade.” Bryan’s attention peaks whenever either Rogers or Davis presents material. This time, he was almost late for his son’s kindergarten graduation in order to hear Davis in person.
Davis started with the disclaimer all of us must understand. NO ONE can know the short-term direction of anything. He supported this with a variety of examples, like “The Wall Street Journal of Survey Economists” from 1982 through 2009. Each reading purported to predict interest rates six months in advance. They were right on the direction of change only 19 of 55 times. That is just 35% of the time. Predictions of interest rate levels were almost never even close.
The “disclaimer portion” of Davis’s talk had slides covering a variety of market and economic indicators with similar lack of predictive value, followed by an Allen Greenspan quote, “The trouble is, we can’t figure it out. I’ve been at the forecasting business for 50 years, and I’m no better at it than I ever was, and nobody else is either.”
Yet, we always expect someone to give us a prediction. The title for the talk raises attention. This doesn’t mean there is nothing to learn from the talk. Many people agree that predicting the short term is futile. Then, those same people rationalize changes in their portfolios by saying “I want to increase cash because I feel the next six months will be troubling for stocks” or “I think we should take advantage of the market being down today.” In the week after returning, we heard both these sentiments expressed with equal sincere conviction. It becomes our job to somehow help people mitigate these impulses, while understanding that both believe strongly.
This is why our education requirements include a healthy allotment of investment counseling. Is it too bold to say; “If Chris Davis, John Rogers, Chuck Royce (Click here for our piece on Royce), Allen Greenspan, Warren Buffett, and a host of other equally impressive people can admit they don’t know what will happen in six months, why do you think you know?” We need a way to share the success of people who have stood the tests of many volatile markets.
In spite of the overwhelming evidence that people cannot predict the future, it is very difficult to mentally recognize the difference between the ways we feel and the things we know. They are not the same. People seem to have an exceptional propensity to “drive their investment buses over the cliff.”
Davis had slides demonstrating the impact of decisions rooted in beliefs. From 1992 through 2009 the average stock mutual fund return was 8.8%. Wow! Shouldn’t we be happy with that? All you had to do was own an average mutual fund. Alongside this, Davis showed that the average stock mutual fund INVESTOR earned only 3.3%. The 5.6% difference is called the “Investor Behavior Penalty.” Keying off this example, he brought home the concept that good mutual fund management can go only so far. He encouraged us to understand that it is our job to help clients maintain discipline and consistency through times when acting on feelings tends to override almost everyone’s statement that they do not believe in market timing.
So, if we cannot predict what is going to happen in the next six months, how can we answer this question, “Is the recovery for real?” On January 4, Resource Advisory Services published our thoughts on the “lost decade” and what it means in the scheme of things. That piece can be found by clicking here.
With Davis’s help, we can add to those thoughts. From 1928 through 2009, just eleven ten-year periods had S&P 500 Index returns less than 5%. This in itself tells us that “lost decades” do occur and economies survive. Four of those were associated with The Great Depression and one with WWII. Four more were during the Vietnam War, when I was studying finance in undergraduate school. Now, the last two of these eleven are associated with a wildly over priced market in 1999, the Terrorist Attack of 9/11 and the most recent market trouble. Will looking at the relatively rare “lost decades” help us know whether this recovery is for real?
We can first notice that our economy has recovered from nine of the eleven occurrences and the current one is the only one that has not had time for a recovery. Let’s look at what happened after the weak ten-year periods before the recent one. They were not all negative, just with ten-year returns below 5%. In every case, the following ten years produced acceptable annualized returns. The weakest was 7% and the best was 18%, with an average of 13% per year. I don’t know anyone who would object to any of these results.
Should we follow those who predict the market for the coming six months based on whatever is happening now? Should we react from the ways we feel? We think it is better to admit we do not know about the coming six months and take our clues from much broader information. Every market crisis is different, except for all the ways they are the same. One of the ways they are the same is that many people say “this time it is different.”
January 4, 2010, we published this. “So, now we have a decade that is widely described as ‘lost,’ with ten years measured from a time when stocks were clearly overvalued. A question at the beginning of 2010 is whether stock returns have been below the trend line long enough to make another growth period as likely as the collapse was in 2000. In 2012 and 2013, the ten-year return will be measured from near the bottom of the market after 9/11. If overall stock market values stay essentially where they are now, that ten-year return can look quite respectable. If stock prices increase, that ten years can look remarkable.”
As the first months of 2010 unfolded and the rally that started in March 2009 continued, we developed increasing comfort. So, what does the volatility of the past several weeks mean in all this? Soon after we returned from the NAPFA Conference we found a piece from Fidelity Investments, which looked at past recoveries. Those rallies have followed remarkably similar patterns. In almost every case, there was a period of exceptional volatility at about this period after the low point. Except for one item, the current volatility seemed to fit those previous recoveries quite well. This time, the volatility “ramped up” faster than it did in most of the other cases, but this is only one of several measures. Otherwise, there was compelling evidence that the volatility of the recent weeks is just another normal part of recoveries.
As much as I wish we could say we have evidence that this recovery is absolutely certain to be for real, we cannot. We never can say that. Nevertheless, like our colleagues who seemed so very calm in Chicago, we have so much experience with these things; we can behave somewhat like Chris Davis, John Rogers and Chuck Royce. People who stray from the discipline do worse than those who are consistent with a good investment philosophy. It doesn’t have to be a great investment philosophy, just a good one, so long as there is discipline in applying it. The recovery will be for real, and it may be for real now.
A related amusing video can be found “It Won’t Go to Zero.”
For additional discussion of perspective read The Wisdom of Great Investors. Also, Bryan or I will be glad to discuss all the slides in the Davis presentation if you like.