A changing market environment

Over the last 100 years, stocks have averaged around a 6.5% real return per annum. This is the biggest reason that investors such as Warren Buffet adopt a buy and hold strategy. It’s why investment advisors tell you that time in the market is the most important aspect of investing, and you should forget about timing the market.

If stocks fall this year, they will bounce by more next year, or the year after. Losses will be reversed, and growth will return. History tells us this is so. You just have to hold your nerve. So goes conventional wisdom.

No one questions how economic growth can average less than half the growth in stock values. Each year for the last hundred years, GDP has grown by 3% or so. Meanwhile the value placed on stocks by the investor has grown by more than double that, each year. At some point this discrepancy had to right itself. I believe we are at that time now, and have been for the past decade or more. Investors just haven’t realized it.

Equities have seen reasonable growth this year. The Dow Jones Industrials (^DJI), for example, has risen by 10% since the turn of the year. That puts it at the same level as September 2007, and just 17% higher than at the turn of the millennium. The Nasdaq 100 (^NDX), is actually down by 23% since the end of the 20th century, though it has risen 15% this year.

Canadian equities, as measured by the TSX Index (^GSPTSE), have risen by a far healthier 34% since the turn of the century, helped higher by the rising gold price, but fallen by around 9% this year as gold and metal stocks have fallen out of favor.

Related: Don’t Confuse Value with Price

In the United States, the growth of GDP has averaged around 2.5% per year since 2000 (world databank). Over the same period, the S&P 500 has averaged a growth rate of a little over 0.3%. Sure, you would have received dividends at an average of around 1.9% per annum. But this still places the return from equities at a far lower rate than the 100 year average. If we look at the tech heavy Nasdaq 100 Index, then returns over the period would have been negative. Equities are playing a game of negative catch up.

In Canada, equities have fared a little better. Since the start of the new millennium, the equity market has put on an average of 3.3% per year, as against an average GDP increase of 2.5%. Thank goodness for gold, which has risen by some 500% in the same period that equities have stagnated.

It’s my contention that this lower rate of equity performance is likely to continue for some time to come, as long term stock market growth moves to equilibrium with long term growth in GDP.

There will, of course, be periods when equities rise strongly. But that strength is likely to be more sanguine than previous: this year’s performance in the Dow Jones Industrials, for example, might be a new level of outperformance rather than the massive rises we’ve seen after previous stock market shocks.

A buy and hold strategy takes no account of the changing economic or business cycle. More adaptability, a greater flexibility, and a more concentrated cyclical style will be needed to take full advantage of the new market environment.

Individual investments need greater focus

Further, a buy and hold strategy take no account of the changing fortunes of individual companies or industrial sectors through the economic cycle. For example, consider an investment made in 2000 in BP. Shares bought at around $33, as against a value now of $43. That’s a rise of 30% over the 12 years, plus dividends. But if the shares had been sold when the Deepwater debacle first reared its ugly head, then you would have sold at around $57 in 2010: a rise of 73%. Buy and hold would have cost you a small fortune: a more proactive strategy would have locked in a great performance.

I don’t need to explain what kind of returns a buy and hold strategy would have yielded in the financial sector during the last few years.

Related:  Truly Diversified Investments or Fourteen Similar Golf Clubs?

Is a buy and hold strategy right for you?

A buy and hold strategy doesn’t work in today’s equilibrium seeking market. Nor does it work for individual companies or industrial sectors. Buy and hold leaves all to luck, which has now run out.

But nor does a buy and hold strategy work for you as an individual investor.

Your investment profile changes over time, as does your attitude to risk. Circumstances change. You lose jobs, and you gain jobs. You get married, have children, and need to pay for their education. You may face redundancy, or disability.  An illness might strike you down from work for several months. All of this, and more, will change how you feel about your investment over time. It will change your aims for your cash, and your needs for your investment. The need for growth today may turn to a requirement for income tomorrow.

Buy and Hold: Defunct for the market, defunct for you

Buy and hold is a strategy that has worked for years, even decades. But it is now defunct. On both an economic and personal level, a more active approach will win for years to come, perhaps even decades. Your life doesn’t stand still: don’t let your investments.