SMI Visitor's Weblog       

Welcome to the SMI Visitor's Blog where you'll find selected excerpts from our Member's Blog, plus occasional posts created especially for our visitors.

For SMI Web Members, click here to go to the SMI Member Blog.

« Blog Home

Encouraging news for long-term investors

In January of 2009, with the market still mired deep in the clutches of the bear market, I blogged about an article that claimed stocks were farther below their long-term price trend than they had been at any time in the past 200 years. The authors concluded that stocks had gotten so far below trend that it was very likely they would "revert back towards the mean" before much longer.

It took another six agonizing weeks for that bear market to find bottom, but their claim turned out to be true. The stock market shot up roughly 70% after that.

Anybody curious what that indicator is showing today?

Me too. And thankfully, the authors recently published a new article detailing that information.

As the chart shows, despite the huge rebound in the market over the past year, stocks are still 27.9% below their 200-year trend. That's obviously not as far below as the 43.1% they reached at the market bottom last March, but still significantly below the long-term trend shown by the red line.

What does this mean exactly? Unlike a year ago, the predictive value of this over the short-term is probably relatively limited. Past experience indicates that the market can stay below (or above) trend for an extended period of time. So unfortunately, we can't really look at this and conclude that a strong rally back towards the trend line is imminent.

However, for long-term investors, the chart has an encouraging message. Simply put, the 200-year track record of the chart says that stocks are likely to produce better returns than their historical long-term average until they "catch up" to the trend line. Maybe not this year, or next, or for the next 5-10 years even. But time after time those two lines have separated and then converged, and it's likely to happen again before too long. It could take a decade, but long-term investors have time on their side.

I recognize that this is difficult to accept for many people who look at the long-term challenges facing our economy and our country. But keep in mind that all of the problems we see are already known and factored into the stock market's current valuation. The stock market is a forward-looking discounting mechanism that has all that known bad news already "baked in."

That forward-looking discounting, coupled with the tendency shown in the chart for the market to revert to the mean, causes the market to continually deliver the exact opposite of what most investors expect.

That's why (in hindsight) a time like 1999 and early 2000 can be a poor time to invest, despite the fact that the external conditions seem to look great. And it's also why hindsight may well show the current period to be a good time for long-term investors to invest, despite external conditions seeming to look poor.

Powered by Movable Type  |   Subscribe  |   Email Updates