Clap If You Believe in Rallies: '00s Weren't That Bad

Paul J. Lim, a senior editor at Money magazine, recently published an article in The New York Times under the headline "Hold the Applause for This Rally."

Lim noted that the S&P 500 is 24% lower today than it was on March 24, 2000. He issues a cautionary quote from Jeffrey N. Kleintop, chief market strategist at LPL Financial, who believes that, if the current rally continues through 2010, "it is unlikely to be anywhere near as rewarding as the past one."

Lim also quotes Jeremy Grantham, chief investment strategist of GMO, who warns investors not to be "... conned into believing that every bad decade is followed by a good one."

Robert Arnott, Chairman of Research Affiliates, agrees. He has a "... cautious outlook."

Should investors gives these views any weight in making portfolio decisions?


S&P 500 Is Just One Piece of a More Prosperous Pie

Lim overstates how bad the last decade was for stocks. As Allan Roth noted in an excellent (and far more accurate) assessment of the last decade at CBS, measuring the performance of the stock market by reference to the S&P 500 index is a fundamentally flawed technique, for a number of reasons.

First, the value of the index ignores the more than two percentage points a year generated from dividends paid by the underlying stocks. Compounded over time, these dividends can equal more than 50% of total returns.

Second, the S&P 500 index also does not include international, mid-cap or small-cap stocks, so it's not an accurate proxy for "stock market returns."

Finally, the index does not reflect the fact that intelligent investors allocate their portfolios between stocks and fixed income. As Roth accurately notes, "[D]efining the decade's market performance using just one piece of the pie is the wrong way to look at it."

The reality is that, for the past decade, U.S. stocks were flat, international stocks increased 2.3% annually and bonds increased 6.2% annually.

So much for historical perspective.

So, Mr. Expert: How Good Was Your Crystal Ball?

Whenever I read the predictions of the "experts," I feel compelled to check their track records, particularly for 2008. After all, you would think that someone with predictive powers should have been able to call the worst recession since the Great Depression.

When LPL issued its "Research Outlook for 2008," Kleintop's name appeared on the report as chief market strategist. Under the heading "Forecasts For A Great 2008", the report predicted "... a great 2008 for the stock market with the S&P
500 posting a gain of 10-16% to end the year within our target range of 1675-1775 ...."

The S&P 500 closed 2008 at 903.25, far below the projected "target range."

Arnott accurately predicted stock prices, corporate earnings and economic growth would fall in 2008. However, he also predicted a "marvelous recovery" in financial stocks in the second half of 2008.

Financial stocks lost 58% of their value in 2008.

Jeremy Grantham first warned of a coming bust in equities in January 2000 and continued to advise investors of problems with the equity markets through the 2008 crash.

Just Say No to Gurus

The markets may take off, or they may tank: The harsh reality is that no one knows, including "financial experts" who are comfortable predicting the unknowable. They may be right or wrong, but their views should be irrelevant to investors.

Don't be distracted by trying to determine the direction of the markets or by trying to find an investment "guru" who has accurate predictive abilities. In both bull and bear markets, you are far better served by determining your asset allocation, investing in a globally diversified portfolio of low-cost stock and bond index funds, and rebalancing when your asset allocation no longer reflects your tolerance for risk.

Investors should ignore brokers', advisers' and the financial media efforts to beat or time the markets. It's all just noise in the channel, with the potential to distract investors from achieving market returns that are theirs for the taking.

Hold your applause for Paul Lim's article.