Opinion: Stocks are money makers now but be aware that some investors
How many years of lagging stock portfolio returns would you tolerate in order to avoid the bursting of a stock market bubble?
That in effect is what Wall Street’s “permabears” are asking. They’ve been bearish on U.S. stocks for a number of years now, and therefore they (and their clients) have missed out on one of the most powerful bull markets in U.S. history.
Jeremy Grantham is one of the most prominent permabear; he is co-founder of Grantham, Mayo, & van Otterloo, a Boston-based asset management firm that is commonly known by the acronym GMO. Grantham has a number of impressive market calls to his credit, including largely sidestepping the bursting of both the internet bubble and the Great Recession. But he is not always bearish. In March 2009, the month in which the Great Financial Crisis-induced bear market came to an end, Grantham surprised many on Wall Street by penning a letter imploring managers to develop a plan for getting back into stocks.
Yet in most financial circles, in which a “what have you done for me lately” attitude prevails, Grantham is known for failing to anticipate the past decade’s bull market. Back in 2010, barely a year after the U.S. bull market began in March 2009, GMO projected that U.S. large-cap stocks would barely outperform inflation over the subsequent seven years.
As we now know, of course, U.S. stocks in recent years have been beating inflation by historic margins. Since 2010, the S&P 500’s
SPX,
inflation-adjusted total return has been 12.5% annualized.
GMO’s response, in effect, is that caution could be vindicated and it would get the last laugh. In a recent analysis entitled “Wounds That Never Heal,” GMO argues that all it would take would be something similar to the bursting of the internet bubble in March 2000 or the bear market that accompanied the stagflation era of the 1970s.
Since this response is self-serving on GMO’s part, I decided to independently measure the long-term impact of living through the bursting of a bubble. What I found is sobering indeed. There have been occasions in U.S. stock market history—not as infrequent as we would like — when unlucky investors lost so much that it took a generation or more to recover.
If Grantham is right that the current stock market is forming a bubble that is about to burst, he’s also right that “for the majority of investors today, this could very well be the most important event of your investing lives.”
The 6% solution
One way of measuring the lingering effect of a bubble bursting is to calculate how long it takes for the stock market to make it back to its long-term trend line. Since 1793, according to research from Edward McQuarrie, an emeritus professor at Santa Clara University’s Leavey School of Business, the U.S. stock market has produced an inflation-adjusted total return of 6.05% annualized. For illustration purposes, I’ll round that to six percent.
Imagine an investor…
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