Trader’s Narrative

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In late November 2008, the S&P 500 index was trading at 850, when we looked at a chart of the 10 year rolling returns. The 10 year return back then was -23% - although horrendous, not one of the worst we’ve seen in history. It still made me consider that it was reason enough Why Long Term Investors Should Consider Buying:

Flash forward a few months to take into account the continued erosion of the S&P 500 and we have the updated chart above. Using the most current data, we have a rolling 10 year return of -45.67% (not including dividends).

How bad is that? There are only a few months that were worse. And they were all around the 10 year anniversary of the 1920’s top:

• 8/1/1939 -61.66%
• 9/1/1939 -59.20%
• 7/1/1939 -58.88%
• 4/1/1939 -57.16%
• 6/1/1939 -56.29%
• 5/1/1939 -56.24%
• 5/1/1940 -55.81%
• 6/1/1940 -55.07%
• 10/1/1939 -53.91%
• 7/1/1940 -52.56%
• 4/1/1940 -51.81%
• 3/1/1939 -51.28%
• 8/1/1940 -50.94%
• 2/1/1939 -50.38%
• 1/1/1939 -49.72%
• 3/1/1940 -49.25%
• 9/1/1940 -48.85%
• 2/1/1940 -47.03%

The monthly data I used went from January 1st 1910 to present (March 1st 2009) so what we are saw as a 10 year simple rolling return is in the worst 1.5% of months for almost 100 years.

Just imagine the stories you’ll tell your grandchildren about the Great Decession. And all the major players: Madoff, Bernanke, Bush, Obama, Greenspan, etc. These are truly historic times we are living through.

Some have written me and questioned the validity of the original market call back in November 25th, 2008. As way of explanation, let me say first, that unlike a loud TV personality, I don’t pretend to know what the market will do - nor am I claiming that you should in me trust (cough Cramer cough). You should base market decisions on your own due diligence. Taking into account something I write is fine, as long as you do your own thinking afterward.

In any case, I made it clear that this was intended for long term investors. Not traders. Long term investors can still make a killing even if they are off a bit. You are either going to get in early, and share in the continued decline of the market, or you’re going to get in late, and pay opportunity costs. But if your time horizon is 25+ years, you don’t really care about a few percentage points here or there, your aim is to catch the big wave.

Even if you disregard the chart above and the fact that we are going through a rare and magnificent opportunity, you have to sit up and take notice when great market timers like Barry Ritholtz, Doug Kass, Jeremy Grantham, Warren Buffett, etc. turn bullish en masse.

Late last year when things were looking down right rotten, I featured a chart of the rolling 10 year returns for the S&P 500 index going back to the early 1900’s: Why Long-Term Investors Should Buy

Since the data was for a simple calculation that excluded dividend reinvestment and the effects of inflation, it raised some questions by readers whether it could be trusted to provide any insight.

Wonder no more thanks to the New York Times. They recently showed that accounting for a reinvested index, adjusted for inflation/deflation, an investor for the past 10 years (including January) would have a return of -5.1%.

This is slightly worse than the previous record set in September 1974 (for -4.3%). The data shows that my hunch was right about reinvested dividends and inflation canceling each other out since the two charts look very similar. The chart they provide doesn’t go back as far as mine but you get the idea:

Source: Off the Charts: The Worst Decade Ever for the S&P

In order to get a long term perspective on the current bear market, I used the date provided by Robert Shiller for the S&P 500 Index (ex-dividend) and starting in 1900, calculated for every month, the rolling 10 year return. The result:

The chart covers almost 100 years of market history and it has a lot to say. The average 10 year return over this time horizon was +89% - the dotted blue line. The following were the tops:

• August 2000 — +365%
• August 1992 — +281%
• June 1959 — +311%
• September 1929 — +247%

Notice how the tops are all around the summer? I know, four instances is hardly a robust sample size but still. If you recall, last summer, Jeremy Grantham was warning his clients the world was a bubble.

Right now, for November 2008, the rolling 10 year return is -25.57%. That is not the lowest but it is quite low. If we assume the worst for this month and take the lowest level at which the S&P 500 Index closed last week, then the monthly rolling 10 year return is -36.51%.

To put things in perspective, we’d have to go back to the summer of 1941 to find lower numbers. The lowest point, within the 100 year time frame used, is August 1939 which provided a soul crushing 10 year return of -62%. Not at all surprising since it is the 10 year anniversary of the great bubble top of the 1920’s.

The other low point occurred in June 1932 with a 10 year return of -43.55%.

Can things get worse? Of course. But at this point, if you have a long term time horizon, a cast iron stomach for risk, the data suggests you should be taking small positions and slowly adding to them cautiously, even if the market continues to tank. That may sound crazy, but where we are right now in market history, only comes about very rarely.

Getting back to Grantham, right now, he is warming up to the equity markets, not just in the US but around the world. In this recent interview, he outlines why he is cautiously bullish and how he is trying to balance two kinds of regrets: getting in too early (more losses) and missing the boat on a rally.

You can also read his most recent quarterly letter in which he goes into much more detail (look in the Reports and Articles folder).

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