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Buy-and-Hope Investing


Look for ways to get real value, absolute returns.

Ihe initial valuation of the stock market when you invest plays an enormous role in your subsequent long-term returns.

This is clearly borne out by the data: The chart below shows that the lower the valuation of the S&P Index in terms of the price to earnings ratio (P/E), the greater your subsequent 20-year returns.

Most people think 20 years should be considered long-term. Looking at the S&P 500 over the past 109 years, you can find many 20-year periods where returns were less than 2%-3%. And if you take into account inflation, you can find many 20- and 30-year periods where returns were negative!

So, knowing where we are in terms of P/E ratios today is very important, as it gives us a small clue as to what our prospects for returns are in the next few decades.

My good friend Peter Bernstein (who at 89 is still one of the most insightful and important analysts in the world) wrote a very insightful essay in the Financial Times called "The Flight of the Long Run." Let me quote a few selected paragraphs:

"The cold statistics have hardly been encouraging for the traditional [buy and hold] view. On a total return basis, the Ibbotson data show that the S&P 500 has underperformed long-term Treasury bonds for the last 5-year, 10-year, and 25-year periods, and by substantial amounts.

"These data are not to be taken lightly. If the long-run expected return on bonds in the future were higher than the expected return on equities, the capitalist system would grind to a halt, because the reward system would be completely out of whack with the risks involved. After all, from the end of 1949 to the end of 2000, the S&P 500 provided a total annual return of 13.1%, while long Treasuries could grind out only 5.8% a year.

"Relying on the long run for investment decisions is essentially relying on trend lines. But how certain can we be that trends are destiny? Trends bend. Trends break. Today, in fact, we have no idea where any trend lines might begin or end, or even whether any trend lines still exist."

Gentle reader, pay special attention to this next paragraph:

"... There is an even deeper reason to reject the long run as a guide to future investment policy. The long-run results we can discern in the data of stock market history are not a random set of numbers: each event was the result of a preceding event rather than an independent observation. This is a statement of the highest importance. Any starting conditions we select in the historical data cannot replicate the starting conditions at any other moment because the preceding events in the two cases are never identical. There is no predestined rate of return. There is only an expected return that may not be realized."

For those of you who invested in 1997 with expectations of 15% forever, you can sadly confirm that last sentence.
No positions in stocks mentioned.

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