A lot of friends who dabble in the stock market have been calling me lately to pick my brain about this or that Internet stock. Of course, any word of caution or concern I express over lofty valuations invariably falls on deaf ears.
God forbid I actually say anything positive about an Internet company. I honestly think my starry-eyed buddies would gleefully invest their life savings. Of course, Internet stocks couldn’t care less about my opinion of them. Had I invested my life savings in such equities two years ago, I might be retired by now. But the past is past and exceptional returns are just that – an exception, not the rule.
People have a habit of forming broad generalizations based on evidence before them. Even the paper’s mutual fund roundup is broken down by quarter and 1, 3, 5 and 10 years. That means 10 years provides an accurate picture of long-run performance, right?
Of course not. Even 20 years is too short a period of time to draw any meaningful conclusion about return (and risk, for that matter). For instance, the annualized total return of the S&P over the last ten years has been 19.2%! As such, there now exist investors who firmly believe that 20% is a realistic expectation of long run return. But consider this: if one optimistically assumes that average US corporate profits will grow 10% annually over the next ten years, while the S&P continues to return an annual 20% over the same time period, then ten years from now the S&P will have a P/E ratio of 77! Given a historical S&P P/E of around 14, is it plausible? I think not.
I’ve seen individuals similarly misdraw conclusions about international investing. Even more disconcerting are those who’ve concluded that diversification of any kind is a waste. They’ve evidently made so much money on a handful of tech stocks that they’re convinced that all of the best companies are in the US and easily identifiable (simply those whose stocks have performed exceptionally over the past few years). As such, it makes no sense to dilute “huge future profits” by diversifying into investments which have lagged lately. Such individuals pooh-pooh international equities and seem willing to totally write off the emerging markets. Yet, just five years ago the “long run” track record of emerging market stocks trounced that of the US. And more than 20 years of data supported the proposition that foreign stocks provide higher returns than US stocks. In short, some investors have lost touch with the concept of risk, and the line between the past and the future has blurred.
In the twenties many thought they were on the road to riches. But a long and unanticipated detour presented itself in 1929. By the late 1940’s and early 1950’s, shaken by economic destruction, most people considered the stock market to be a low-return, high-risk game best reserved for millionaires. (A pension or endowment fund manager might have been sued for imprudence had he invested as much as half of his assets in stocks!) The stock market was erratic until the early eighties. At that time, inflation and interest rates peaked and they’ve been gradually declining ever since. Now, with nearly twenty years of exceptional stock market returns, people have ratcheted up expectations to perhaps record levels. Fund managers can actually be fired (and regularly are) for not being fully invested in the stock market!
I would venture to guess that the next ten years will not resemble the last ten years in terms of global stock market risk and return. I believe that one is more likely to find the next great ten or twenty-year market rally overseas, in the markets of countries whose economic situation looks bad and whose past performance is quite unimpressive. A country that fits this description, whose leaders take the steps necessary to place its economy on sound footing, has all the ingredients required to generate extended excellent returns. That’s what the US looked like to the world twenty years ago.
