A Decade-and-a-Half for (Not Quite) Nothing

Lessons from a fairly comfortable bear market…if you could keep your cool


In a recent paper (1) I commented on the stock market’s January behavior, mainly to argue that trying to find fundamental causes for short-term market fluctuations is a futile endeavor, since most of these short-term moves really are psychologically driven.  But it then occurred to me that it would be useful to place these comments into a longer time frame as well.

I have often insisted that, in measuring investment returns, the selection of the starting date for the period being measured is critical.  Another commentator once pointed out that measuring the stock market performance from bottoms to peaks of market cycles, as we are tempted to do, leads to very misleading (inflated) conclusions about the potential returns normally available from stocks.  He advised, instead, always to measure stock-market returns from the peak of one cycle to the peak of the next cycle.  It made sense to me: measuring the stock market performance from the trough to the peak of a cycle would be tantamount to measuring global warming only between the coldest days of winter and the hottest ones of summer. With this in mind, I looked back at the 2000-2015 stock-market episode.

Why 2000-2015?  It’s Secular

Most students of so-called secular market cycles (those lasting many years, as opposed to shorter seasonalcycles) view the year 2000 as the peak of the last secular bull market (rising) and the beginning of the currentbear market (declining).

Between 3/31/2000 and its recent peak on 5/31/2015, the S&P 500 index gained 41 percent. Over 15 years, however, this is barely more than 2 percent per annum – a quasi-stagnation in modern stock-market lore.  Further, over this 15-year cycle it has displayed significant volatility – both up and down, as can be seen on the graph below.  So one may well wonder why many experts label this a secular bear market, especially since, in the end, it managed to eke out a modest but real net gain for the period. (2)


However, the kind of volatility observed in 2000-2015 is not atypical for periods categorized as secular bear markets, as illustrated by the 1965-1981 secular bear market fluctuations (below).


There are a few differences among analysts and scholars over the exact timing of the onset and completion of secular cycles.  But these differences are relatively minor since, by and large, studies of secular cycles focus more on the trend of price/earnings (P/E) ratios than on the trend of stock prices themselves.  The reason is that, as a measure of how much investors are willing to pay for $1 of earnings, P/E ratios are akin to bids in an auction process -- a direct reflection of the enthusiasm or pessimism of the investing crowd.  They are also more volatile than corporate earnings, and as such, they can be viewed as the main factor shaping stock-market cycles.


The chart above shows that multi-year bull markets have historically alternated with multi-year bear markets.  However, while secular bull markets have been characterized by strong advances in stock prices, secular bear markets have tended to be periods of flattish performance on a net basis over the duration of the bear.

This apparent asymmetry can be clarified by looking at the lower part of the chart.  Bear markets were periods of declining P/E ratios, which is not too surprising since many experts define secular bull and bear markets by their P/E ratio trends.

This phenomenon was studied by investor Vitaliy Katsenelson:  When the market went sideways instead of down, as it often did, it was generally because rising earnings were offset by declining P/Es, a defining characteristic of bear markets. (3)

Dumb Money

Of course, many investors are tempted to catch the intermediate cycles that populate secular or sideways bear markets.  Some occasionally succeed but, in my observation, most fail in the end.

I am not sure who invented the term “dumb money” to describe investors whose investments systematically underperform, but a 2005 study of the “dumb money effect” by two professors at the University of Chicago Business School and the Yale School of Management has become a classic. (4)  Their conclusions were fairly unequivocal:

We use mutual fund flows as a measure for individual investor sentiment for different stocks, and find that high sentiment predicts low future returns at long horizons....  By reallocating across different mutual funds, retail investors reduce their wealth in the long run….  Individual investors have a striking ability to do the wrong thing.  They send their money to mutual funds which own stocks that do poorly over the subsequent years.  Individual investors are dumb money, and one can use their mutual fund reallocation decisions to predict future stock returns.

This certainly matches my casual observations over the years.  I only regret that the authors decided to concentrate on individual investors, for I really see little difference between the “crowd” of individual investors and the “crowd” of professional investors:  A crowd is a crowd and, by definition, only investors that dare to be different from it have a chance to be better than it.

The destructive tendency of investors to switch mutual funds or investment managers on the basis of recent performance has also been confirmed time and again in the financial services market-research firm DALBAR's annual Quantitative Analysis of Investor Behavior (QAIB) (5):

Most equity fund investors earn less than inflation as they try fruitlessly to buy low and sell high.  Motivated more by fear and greed than intellect, these investors chase market returns to the detriment of their pocket books.  (2004 edition)

Since 1994, DALBAR's QAIB has been measuring the effects of investor decisions to buy, sell, and switch into and out of mutual funds over both short- and long-term time frames.  The results consistently show that the average investor earns less – in many cases, much less – than mutual fund performance reports would suggest.  (2015 edition)

Trading mutual funds and trading investment managers share the same psychological roots and tend to have the same performance-impairing results, as Seth Klarman argues in “The Institutional Performance Derby: The Client Is the Loser” (6):

Like dogs chasing their own tails, most institutional investors have become locked into a short-term, relative-performance derby….  Frequent comparative ranking can only reinforce a short-term investment perspective.  It is understandably difficult to maintain a long-term view when, faced with the penalties for poor short-term performance, the long-term view may well be from the unemployment line.

The short-term orientation of money managers may be exacerbated by the increasing popularity of pension fund consultants.  These consultants evaluate numerous money managers, compare their performances, contrast their investment styles, and then make recommendations to their clients.  Because their recommendations can have a significant influence on the health of the money management business, the need to impress pension fund consultants may add to the short-term performance pressures on money managers.

What is a relative-performance orientation?  Relative performance involves measuring investment results, not against an absolute standard, but against broad stock market indices, such as the Dow Jones Industrial Average or Standard & Poor's 500 Index, or against other investors' results.  Most institutional investors measure their success or failure in terms of relative performance.  Money managers motivated to outperform an index or a peer group of managers may lose sight of whether their investments are attractive or even sensible in an absolute sense.

Instead of basing investment decisions on independent and objective analysis, relative-performance-oriented investors really act as speculators.  Rather than making sensible judgments about the attractiveness of specific stocks and bonds, they try to guess what others are going to do and then do it first.

These arguments against the relative-performance game must be music to the ears of my partner Robert Kleinschmidt:  He always teaches our junior portfolio managers not to reach for the moon because “extremes” of performance on the high side are almost inevitably followed by “extremes” on the downside.  One or two great years may be wonderful for a manager’s ratings, but steady, absolute enrichment is more beneficial to our clients’ welfare.

The 2000-2015 Secular Bear-Market Experience

The reason I often quote other investors to discuss performance is to avoid turning what should be communication into a promotional exercise.  The investors I quote have indisputably superior long-term records, of a quality and historical length that I have yet to see from the kind of consultants portrayed by Seth Klarman.

Which brings me to the observation that, investors who stayed invested (in an S&P 500 tracking fund, for example) from the May 2000 high to the recent May 2015 high would have achieved a total return which, while modest by historical standards, would have bested the performance of most investors during that period.

I did discuss our performance in two previous papers, (7) however, mainly to illustrate the response of portfolios and investment styles to various cycles.  For this purpose, I used a sample Tocqueville portfolio, which I chose for three reasons (see disclaimer at the end):

• It has been and still is our firm’s largest account;
• It is the one that I have managed for the longest time – since 1976, either alone or in collaboration with colleagues, but without outside interference; and
• It is the only one with an audited performance going back almost 40 years.

On the table below, one can see that when dividends are included and reinvested, the total return for the S&P 500 over the period 2000-2015 actually was 88.2 percent, or 4.3 percent per annum.

             Time Period        S&P 500     Sample Account 
                           w/ Income     (Net of Fees)
             3/31/2000      100.00      100.00
3/31/2000 to 3/31/2001       78.32       98.39
3/31/2001 to 3/31/2002       78.51      113.52
3/31/2002 to 3/31/2003       59.07       91.70
3/31/2003 to 3/31/2004       79.82      142.05
3/31/2004 to 3/31/2005       85.16      156.53
3/31/2005 to 3/31/2006       95.15      191.32
3/31/2006 to 3/31/2007      106.40      209.21
3/31/2007 to 3/31/2008      101.00      208.25
3/31/2008 to 3/31/2009       62.53      143.46
3/31/2009 to 3/31/2010       93.65      209.03
3/31/2010 to 3/31/2011      108.30      247.46
3/31/2011 to 3/31/2012      117.55      241.33
3/31/2012 to 3/31/2013      133.96      256.15
3/31/2013 to 3/31/2014      163.25      301.67
3/31/2014 to 3/31/2015      184.03      315.69
3/31/2015 to 5/31/2015      188.18      322.64
Growth from 3/31/2000        88.18%     226.64%
Growth Annualized             4.26%       8.03%


This 4.26-percent annual return was well below what is considered to be the long-term growth trend of the stock market (9 percent per annum (8)), but still more than twice the inflation rate over that period.  And to get this return, you did not need to do anything special – just stay put with your positions.

But if, instead of passively mimicking an index such as the S&P 500, you followed a true long-term discipline of stock selection, you could significantly outperform the “market” without any heroics – either in endeavor or in method.  This is what the following chart, based on the earlier table, depicts:


The returns discussed in this graph are based upon the annual returns for fully discretionary accounts managed by Tocqueville Asset Management and François Sicart, founder and chairman, for its largest client. Performance data quoted represents past performance and does not guarantee future results. The client account includes investment in foreign securities, which involves greater volatility and political, economic, and currency risks and differences in accounting methods. The S&P 500 Index is a market-value-weighted index consisting of 500 stocks chosen for market size, liquidity, and industry-group representation. The S&P 500 Index returns include reinvestment of dividends. The volatility and other risk characteristics of the S&P 500 Index may be greater or less than those of the client account. You cannot invest directly in an index. Other accounts were managed by Mr. Sicart during the same period, and may have had different investment objectives and achieved different results. A new account with similar investment objectives and style may not achieve similar results.

As I alluded to earlier on, I cannot take full credit for the recent statistics above.  Today this account is managed by several teams within Tocqueville, which share one philosophy (fundamental research and a longer-than-average time horizon) but apply it with slightly different disciplines when dealing with somewhat different universes.

For example, traditional valuation methods are often difficult to apply to new, emerging technologies, social networks, the new virtual economy, or the biotech sector, which represent hundreds of billion dollars of market value and cannot be ignored.  A more-forward look at their long-term potential is warranted when doing valuation work, and a new generation of analysts/portfolio managers is well equipped to provide Tocqueville with a window on these new opportunities.  Most of them have been with us for a number of years; they currently are being vetted under our supervision with some portions of our larger accounts.

Secular Lessons: Is the Potential Reward Worth the Risk?

When one thinks of all the disruptions that have marked this decade-and-a-half – political uprisings and revolutions, epidemics and natural catastrophes, as well as the bursting of the Internet bubble in 2000 and the “Great Recession” of 2007-2008, with its laborious aftermath – it is quite an achievement for the stock market to have produced a near-90-percent gain in wealth for investors who simply waited it all out.

For a good part of the past two years, I have personally voiced skepticism toward further market gains.  It was not so much that I predicted what could go wrong with domestic policy paralysis, geopolitical crises, monetary incompetence, or fiscal irresponsibility:  These make good material for cocktail talk but for a serious investor they are just par for the course.  Rather, I get uncomfortable when I detect excesses of optimism or complacencybecause I know from experience that these excesses are reflected in the valuation of financial assets.  As the proverb goes, on Wall Street, “genius is a bull market.”

I have a well-documented tendency to become skeptical of market advances too early. But I believe that worrying simply proves that one is awake.  On the other hand, predicting the market based on opinions would be to dream awake, and it works only occasionally, at best.

Even valuation criteria, such as the P/E ratio, are more valuable than opinions but they still are very imprecise timing tools.  Different versions of the P/E ratio are used for long-term market studies, including the famous Cyclically Adjusted P/E, devised by Nobel laureate Robert Shiller, and a similar one used by Crestmont Research.

These P/E metrics have historically fluctuated within a wide range, between very cheap (6 to 8) and very expensive (20 to 40+).  When P/Es are very high, they are likely to decline eventually, dragging the stock market down with them, or at the very least preventing its progress (sideways markets).  But when and from what extreme level a correction might take place, no one can really tell.

On the other hand, there are good inverse correlations between various P/E levels and stock-market returns over the following 7 to 10 years, meaning that the higher the current P/E, the lower future S&P 500 returns are likely to be. (9)


The current Shiller PE Ratio, at almost 25, seems to imply that stock market returns from current levels will be limited for another decade on a net basis (after the intervening, shorter cycles).  But the experience of the last 15 years should also remind us that riding the cycles is usually better than trying to time them.

François Sicart
February 1, 2015

DISCLOSURE: This article reflects the views of the author as of the date or dates cited and may change at any time. The information should not be construed as investment advice. No representation is made concerning the accuracy of cited data, nor is there any guarantee that any projection, forecast, or opinion will be realized.

We will periodically reprint charts or quote extensively from articles published by other sources. When we do, we will provide appropriate source information. The quotes and material that we reproduce are selected because, in our view, they provide an interesting, provocative, or enlightening perspective on current events. Their reproduction in no way implies that we endorse any part of the material or investment recommendations published on those sites.

1. “Why Did the Stock Market Tank Yesterday?” (Tocqueville, 01/14/2016)
2. Crestmont Research, founded by Ed Easterling, author of Unexpected Returns – Understanding Secular Stock Market Cycles (Cypress House, 2005)
3. The Little Book of Sideways Markets, Vitaliy Katsenelson (John Wiley & Sons, 2011)
4. “Dumb Money: Mutual Fund Flows and the Cross-Section of Stock Returns,” Andrea Frazzini and Owen Lamont, National Bureau of Economic Research (7/2005)
5. “The Mathematical Investor” blog (5/9/2014)
6. Chapter III of Margin of Safety – Risk-Averse Value Investing Strategies for the Thoughtful Investor, Seth A. Klarman (1991, out of print)
7. “Short-Term Gratification and Long-Term Return” (Tocqueville, 09/20/2012) and “Secular Lessons” (Tocqueville, 2/12/2014)
8. According to Professor Jeremy Siegel of the Wharton School, stocks have returned an average of 6.5 to 7 percent per year after inflation over the last 200 years.  Before inflation, this would represent a long-term average return of about 9 percent per annum.
9. Greenbackd.com (4/1/2013)

 François Sicart - Tocqueville Asset Management