When the topic of investing comes up in conversation, I’m often asked to recommend an investment book. Since I’m biased toward the value investing philosophy, one of Benjamin Graham’s books always comes to mind. But what if I were to tweak the question a bit and not recommend an investment book, but only a particular page of an investment book? What single page above all other pages from a book on investing would I recommend?
The performance of gold stood in sharp contrast to the return on stocks over the previous decade. Most people are not aware that stocks had a negative average annual return from 2000 to 2009. This time period produced even worse results than the Great Depression of the 1930s.[I] That terrible performance even assumes an investor reinvested the dividend income on their stock holdings. Given that backdrop of lousy equity performance, gold was viewed by the retail public as the asset class of choice over the previous decade. The chart below shows how gold almost quadrupled in value while the S&P 500 stock index remained slightly below where it started. As gold continued climbing over the previous decade, more investors joined the social contagion bandwagon and diversified into the yellow metal.
We’ve experienced a number of years over the recent past where the broad stock market average produced a negative rate of return. The year 2000, 2001, 2002 & 2008 all produced negative returns for someone invested in a stock index fund. Experiencing the occasional bear market year in stocks is inevitable for those investors following a buy-and-hold approach to stock investing. Given the difficulty in market timing stocks over the long term, buy-and-hold investors will on occasion be forced to endure bear market years in their portfolio.
The retail public enjoys the storytelling of growth stocks and the financial press is more than happy to fill that void. It is easy for an investor to fall into what finance professor, Jeremy Siegel, refers to as a “growth trap”, focusing on stocks with rapid sales and earnings growth in new industries that are highly disruptive. Humans have a predisposition to see patterns where none exist. Connecting the dots and extrapolating above average growth trends far into the future is an example of this pattern seeking behavior. Let’s take a look at the evidence and see if past growth in earnings really does continue into the future for stocks we want to invest in.
How do net current asset value stocks perform when Buffett's favorite valuation indicator is expensive?
Warren Buffett, a former student and employee of value-investing pioneer Benjamin Graham, commented recently on how expensive the overall stock market is currently. One of the metrics Buffett uses to describe the valuation of stocks is to compare the market value of stocks to the size of the U.S. economy. The metric used to measure the size of the economy is the Gross Domestic Product (GDP). Sometimes Mr. Market bids up stock prices to lofty levels relative to GDP, and at other times stocks become depressed relative to the size of the overall economy. This valuation ratio is not a short-term market-timing tool, but it does provide guidance as to whether returns will be above or below the average over the longer term.