2
July
2011
As the USA celebrates it's 235th birthday, Wall Street was in a generous mood by giving nearly a trillion dollars in gains this week. To be more precise, the US stock market rose every day this week, increasing by a total of 5.6 percent, as measured by the broadest US stock index, the Wilshire 5000. This 5.6 percent gain translates to about $910 billion dollars.
The message here for investors attempting to time the markets is that Stocks are always risky. It’s not like when you go to the beach—if there’s a green flag it’s safe, and if there’s a red flag you stay out of the water. There’s never a green flag for stocks. People may think it’s safe like they thought it was safe in the late ’90s. But stocks are always risky. It has to be so. Otherwise there would be no risk premium.
The problem is there’s a difference between risk and uncertainty that many people don’t understand. Most investors focus on the wrong thing. They’re trying to manage returns somehow—either by themselves or by hiring active managers to do it. They’re all playing what Charles Ellis called a loser’s game. You can’t control what you can’t forecast.
As legendary Fidelity fund manager Peter lynch said more money has been lost worrying about the next bear market than is actually lost in the bear market.
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This graph documents bull and bear market periods in the FTSE All-Share Index from February 1955 to December 2010.
The market cycles are identified in hindsight using historical cumulative monthly returns. Monthly index returns are total returns, which include reinvestment of dividends. All monthly observations are performed after the fact. A bear market is identified in hindsight when the market experiences a negative monthly return followed by a cumulative loss of at least 10%. The bear market ends at its low point, which is defined as the month of the greatest negative cumulative return before the reversal. A bull market is defined by data points not considered part of a bear market. The rising trend lines in blue designate the bull markets occurring since 1955, and the falling trend lines in red document the bear markets. The bars that frame the trend lines help to describe the length and intensity of the gains and losses. The numbers above or below the bars indicate the duration (in months) and cumulative return percentage of the bull or bear market. Keep in mind that this graph does not show total compounded returns or growth of wealth.
Once the cycle is established in retrospect, the first month of that cycle resets the performance baseline to zero. Investors may draw a number of lessons from this graph. First, since 1955, bull markets in the FTSE All-Share Index have lasted longer than bear markets and delivered gains that are disproportionately greater than the bear market losses.
Second, fluctuating performance within each trend illustrates that volatility and uncertainty occur even within established market cycles: bull markets may have short-term dips, and bear markets may have short-term advances. The immediate trend is not readily apparent to market observers, and in fact, may become clear only in hindsight. This illustrates the difficulty of accurately predicting and timing market cycles. Finally, the graph suggests the importance of maintaining a disciplined investment approach that views market events and trends from a long-term perspective. Investors who react emotionally to short-term movements are at risk of making ill-timed decisions that compromise long-term performance.
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