The Big Picture – History May Offer Clues As to the Direction of Your Portfolio

As every investor knows the equity markets have been extremely volatile in recent weeks, months and even years. There are many explanations for the extreme volatility and it may be worth “viewing” history to see the bigger picture as it relates to the market’s recent actions and what may lie ahead.

Toward the goal of reviewing market history for clues as to what may lie ahead, we have broken the history of the Dow Jones Industrial Average (DJIA), the Index, into four periods:

1. The post World War II period from 1948-64.

2. 1964-82 (which encompassed the 1973-1974 recession).

3. 1982-1999.

4. 1999 to present.

Let’s begin by looking at the post World War II period which consisted of approximately 16 years; from October 8, 1948 through May 14, 1964. The market experienced a strong period of growth which resulted in a gross index gain of 352.94% and an annualized rate of return of 10.162% for the DJIA. During this period the country experienced an expanding economy which was accompanied by a low interest rate environment and strong employment. Some may remember that there were a group of companies at the time known as the “nifty fifty” which represented a group of stocks that had strong performance during this period.

The next period was 1964 – 1982. The market during this period was characterized by extreme volatility which resulted in the DJIA returning a negative.021%, which annualized at (-.001%) for investors from May 8, 1964 through March 1, 1982. In other words, the 16 year period essentially delivered a ZERO rate of return for investors who owned the stocks comprising the DJIA. As we look back on this period it was marked by a severe recession from 1973 – 1974 and significant interest rate volatility. With respect to interest rates, many investors remember the extremely high rates of the early 1980s.

As the spring of 1982 arrived, the market embarked on a 17 year period where the DJIA grew by an incredible 1,271.75% which annualized at 16.15% for investors. The period, from March 12, 1982 through September 1, 1999 was characterized by significant growth in many areas of the economy, most importantly the technology sector (remember the Tech Bubble?!), and meaningful increases in the level of productivity. Additionally, during this period interest rates fell significantly from the onerous levels of the early 1980s, the employment landscape was stable and tax rates were supportive of capital development. As an aside, how many investors yearn for another 17 year period like this one?

Today, we remain in the period that began in the fall of 1999. Many are already dubbing this period the “lost decade.” The DJIA has returned a negative (-5.69%) since September 3, 1999 which equates to an annualized return of (-0.531%) for investors. Certainly the country and the markets have encountered many challenges during the past ten years such as; the terrorist attacks on September 11, 2001 and the accompanying market volatility of 2001 and 2002 as well as the implosion of the real estate and debt leverage bubble which is blamed for the market crash of 2008.

The question we must ask ourselves now is: Is history simply repeating itself?

Certainly there are specific issues that we can all point to that are impacting the performance of the equity markets. Deleveraging of the real estate bubble and the deleveraging of the bank balance sheets are certainly a fault for the decline from the highs in 2007. Now we are struggling with fears about a double dip recession, high unemployment, the U.S. Dollar, European Banks, the Club Med Countries (Portugal, Italy, Greece and Spain), amongst other challenges. These negative arguments are countered by talks of attractive equity valuations, corporate earnings that have been positive and a sense that the worst is behind us. Thus, I pose the question again; what if the current environment is endemic of historical activity?

To recap the aforementioned market periods we know that during the 16 year period from 1948 through 1964 the economy was growing well and there were few, if any, headwinds which resulted and the DJIA returning slightly more than 10% per year. The following 18 years (1964-82) as the economy digested the growth of the previous 16 years; the market went through significant gyrations with the index returning virtually zero over the period. Additionally, during this period the DJIA experience prices swing of as much as 44%. The next 17 years (1982-99) was greeted with the fastest growth in history and produced a gross return for the DJIA of 1271.55%. Now, we are back in a period of digestion where returns are again flat and the markets are characterized by volatility.

What if the current 10 year period is only the first leg of an 18 year period similar to the 1964 – 1982 period?

If you accept that the equity markets are driven by capital flows and that these capital flows are driven by individuals, then you may agree with the broad conclusion that the market is a representation of investor psychology. If so, then it would seem fair to agree that due to recent events, negative investor psychology has led bankers to avoid risk and to reduce their lending activities, corporate boards are unwilling to make significant capital expenditures and investors are unwilling to accept risk in their portfolios. The U.S. Treasury market would seem to substantiate the reality that investor psychology is broken as treasury bonds have experienced significant inflows of capital from a wide variety of sources which seem to be seeking the relative safety of government bonds. At the same time, investors are eschewing equities as reflected by net outflows from equity mutual funds.

So what should an investor do? First, consider speaking with a qualified advisor to review your current situation. Most importantly, keep an eye on the big picture. While there is no guarantee that the markets will repeat the same cycles as the past, it is worth considering history and investing with a long term perspective in mind.

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