Stock Market

The general focus of the research about the stock market has concentrated on analyzing and developing perspectives about the market over the long term. The research primarily relates to secular bull and bear cycles, their patterns of returns and volatility, and the relationships between the market and the underlying fundamental drivers. Many of the analyses are synthesized into graphics that seek to be self-explanatory. Other postings represent articles that often incorporate and expound upon the graphics. Please peruse the charts and analyses listed below; we encourage you to send your insights and challenges as catalysts for furthering our research. You are welcome to use the graphics and quote the text from this website with appropriate attribution and the retention of all copyright designations. Other terms of use are included in the About section.

Featured Items

Updated
Through Jun 2014

Stock-Earnings-Trend

(periodic updates)

Updated
Through Jun 2014

The P/E Report

(periodic updates)

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Secular Stock Market Cycles

Updated
Through 2013

Stock-Dashboard

Secular Cycle Dashboard 

Mixed signals or confirming signals? There are four variables that determine whether the current secular stock market cycle is in bull or bear territory: price/earnings ratio (P/E), dividend yield, inflation rate, and bond yields. P/E is the pure measure of the stock market valuation level, especially when it is normalized for the business cycle. Dividend yield, directly related to P/E, is a confirming measure that helps to qualify distortions in reported P/Es. The inflation rate is the primary driver of secular stock market cycles. When the inflation rate does not confirm the market’s valuation level, there is likely a cyclical distortion rather than a secular shift or trend (early 2009 is a good example of this contrast). Bond yields, particularly since the 1960s, reflect another financial market perception of the expected future inflation rate. This makes bond yields a confirming measure for secular stock market cycles.

Updated
Through Jun 2014

Stock-This-Secular-Bear

This Secular Bear…So Far 

The current secular bear began in 2000 and has lasted well more than a decade. The surges and falls are relatively consistent in both magnitude and duration with past secular bear market cycles. With valuation levels still relatively high as measured by normalized P/E, this secular bear has quite a way to go.

charts: Past Two Secular Cycles

Deja Vu 

History provides insights when we observe it from the appropriate perspective. The most recent secular cycle, a bull, ran from 1982 through 1999. It was preceded by a secular bear starting in 1965 and ending in 1981. The characteristics of each secular period are reflected in the general direction of the markets and in the frequency of positive returns. As this presentation shows, secular bull periods have generally upward-trending markets and predominately positive (green) annual returns. Secular bear periods are erratic and present a significant number of negative (red) annual returns. The net effect is substantially muted returns due to offsetting positive and negative years. So where are we today? The last secular bear cycle started when the P/E ratio was 23 and inflation was 2%. The current market conditions reflect the same vital signs. Deja vu?

Last Updated
July 5, 2012

Secular-Bear-Example

Secular Bear Example 

The swings during secular bear markets are much more dramatic than most investors realize. Although secular bull markets have similar swings, they are upward-sloping and are often ignored. The last full secular bear market period delivered 16 years of annual changes and 343% cumulative peak-to-trough movements — thus over 21% per year.

charts & analysis: Living through the Last Secular Bear

Living Through the Last Secular Bear 

In 1972, P/Es were almost 18, the market was approaching and exceeding new highs, volatility was low, and the market was in the first half of a secular bear market. What happened next is now history — if it happens again, that won’t surprise the old sages. This presentation is a self-explanatory look at the last secular bear market cycle and a similarly optimistic period during the first half of that cycle.

Updated
Through 2013

Secular Cycle Profile

Secular Cycles 

The stock market has demonstrated longer-term secular bull and bear cycles. Secular cycles are extended periods with a common trend. In the stock market, these secular cycles are driven by trends in the P/E ratio. This chart presents the secular stock market cycles since 1900, based upon Crestmont’s research and analysis of P/E ratios, inflation, and other factors. The cycles correspond with peaks and troughs in P/E ratios, often over extended periods of years. The P/E ratio cycle corresponds with inflation rate cycles as they move toward and away from periods of price stability (low inflation). A version of the secular chart overlaid with detailed explanations of its key features is also available: Annotated Chart.

Updated
Through 2013

Secular Cycles Explained

Secular Cycles Explained 

The long-term view of the stock market reflects extended periods of surge and stall. These periods, known as secular bull markets and secular bear markets, are not optical illusions; rather they are extended periods when market valuations (i.e. price/earnings ratios: P/Es) are either multiplying the effect of rising earnings or mitigating them. Secular bull market periods have always started when P/Es were below average, and secular bear markets have never ended when P/Es were above average.

Updated
Through 2013

Stock Market Matrix

Stock Market Matrix 

Returns depend upon the starting and ending point. This series of charts presents the compounded annual returns for an investor who began investing during any start year since 1900 and ending with any subsequent year. The versions presented reflect returns for taxpayers and for tax-exempt or deferred investors, as well as returns on a nominal and real (after inflation) basis. The charts are scaled for printing on a single sheet of 11″ x 17″ paper or on two 8 1/2″ x 11″ pages for subsequent alignment. See the assumptions and legends for important details.

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Long-Term Returns

article: Groundhog Decade For Stocks

Groundhog Decade for Stocks 

Can anyone predict the future? Probably not, but it is possible to analyze the range of potential outcomes. “Groundhog Decade” summarizes some of the key messages of Probable Outcomes. Just as Bill Murray woke up to the same thing day after day in the movie “Groundhog Day,” it’s likely that your outlook foretells a groundhog decade for the stock market that will repeat its near-break-even returns from the past decade!

Shiller’s Shortfall

Shiller Shortfall 

Shiller shortfall is its strength. The shortfall relates to the results for 2003 from using the stock market index methodology employed by Professor Robert J. Shiller of Yale University (author of Irrational Exuberance), and many other sophisticated experts. The “index value” of the S&P 500 for each year is based upon the average daily index throughout the entire year rather than on only one point at year-end. The strength of the methodology is that it mitigates the “single-point risks” of using one arbitrary value for each year (i.e. year-end). As a result, the average of all days across the year can better reflect the stock market’s level for that year as a whole. Nonetheless, the results using this methodology can vary significantly from actual reported results. Using 2003 as an example, the average index reflects a decline for 2003 rather than the gains reflected in the year-end values. Even though the index increased by +26% from December 2002 to December 2003, the average index for 2003 was -6% lower than 2002.

Updated
Through 2013

Stock Market Yo-Yo

Stock Market Yo-Yo 

Up today and down tomorrow. The stock market seems to be constantly reacting to good news and bad news, sometimes “because of” the news and other times “despite” the news. In this research, we explore the portion of days that the market is up compared to the number of days it is down. Over the past five decades, through secular cycles, decades, and individual years, the range of up-days versus down-days is relatively close to 50%.

charts & analysis: Must Be Present to Win (Or Lose?)

Must Be Present to Win (Or Lose?) 

Participants in our website have remarked numerous times on the appearance that the market’s gains are limited to a small number of days, raising questions about the value of trying to time the market. Although it is technically true that a few days provide the full year’s return, viewing that phenomenon through too narrow a lens is a bit misleading and seems to be a biased use of statistics. Since almost half of the days or weeks are positive (and thus half or so are negative), the majority offset each other. The result is that a few good days or few bad days “make” the year. Of course, this interpretation completely ignores the fact that certain periods have favorable financial potential (secular bull markets) and certain periods have unfavorable financial potential (secular bear markets). The same logic that encourages investors to stay in the market seeking gains also subjects them to the adversity of down markets.

Updated
Through 2013

charts & analysis: Generation Returns

Generation Returns 

Even an extended period of 20 years does not ensure positive cumulative returns in the stock market. Returns appear to be dependent upon the starting level of P/E ratios. When P/Es are relatively high and above the average, investors’ returns over the subsequent 20 years have been below average or negative. When P/Es are relatively low and below the average, investors’ returns have been above average and rewarding.

Updated
Through 2013

charts & analysis: Distorted Averages

Distorted Averages 

Investors can spend only compounded returns, not average returns. This chart presents the difference between average returns and compounded returns for investors. The two issues assessed are the impact of negative numbers and the impact of volatility as measured by the variability within a sequence of returns. Both issues can devastate the actual returns realized by investors compared to the average. The first issue — negative numbers — is demonstrated by this example: an increase of +20% and a decrease of -20% may average zero, yet the net result is a loss regardless of the order in which they occur. The second dynamic — volatility — is illustrated by another example: the compounded return from three periods of 5% returns is greater than any other sequence that averages 5%.

Updated
Through 2013

charts: Components of Return

Components of Return 

There are only three components (excluding transaction costs and expenses) to the total return from the stock market: dividend yield, earnings growth, and change in the level of valuation (P/E ratio). To assess the potential returns from stocks for the next decade, this analysis presents the total return and its components for every ten-year period since 1900.

Updated
Through 2013

chart & analysis: Gazing at the Future

Gazing at the Future 

The starting valuation matters! When P/Es start at relatively lower levels, higher returns follow — paying less yields more. When investors have P/Es that start higher, subsequent returns are lower. This graphical analysis presets the compounded returns that follow over the subsequent ten years based upon the starting P/E ratio. It’s compelling, primarily because it’s fundamental — starting valuations directly impact subsequent returns. From the current above-average valuations, below-average returns are likely to follow for the next decade or longer.

Last Updated
Oct 4, 2013

Waiting For Average

Published Version (includes Markowitz Misunderstood)
Click Here

Waiting for Average 

The long-term average return from the stock market is 9.9%. As the elder Baby Boomers are now beginning to retire, they will be relying upon their investments and pensions for income. The youngest Boomers have less than two decades to compound their savings into a retirement payload. Many Boomers, younger and older, have a vested interest in stock market returns for a secure retirement. So, from 2013, what length of time is needed to assure the long-term average return?

Answer: it will NEVER happen. From today forward, investors will not achieve the long-term average return. Not in ten years, twenty years, fifty years, or the eighty-plus years that represent the most recognized long-term average return.

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Financial Physics

Financial Physics represents the interconnected relationships among several key elements in the economy and the financial markets that determine the stock market’s overall direction. This section and its presentations will provide a highly provocative and insightful perspective on the relationship of the economy ('the source of wealth') and the equity markets ('the measure of equity wealth'). Whereas other sections present analyses of historical data to provide perspectives, this section is dedicated to exploring the fundamental factors and economic relationships that drive trends and valuations in the financial markets.

charts: Dissecting Returns

Dissecting Returns 

Financial Physics presents the interconnected relationships between certain factors in the economy and the resulting environment in the financial markets. This analysis dissects the components of Total Return and looks at the potential returns available for the rest of the decade. Without further, unsustainable increases in valuation (P/E ratios), returns will likely fall short of the historical average. If inflation remains below the historical average (near 3.5%), economic growth (GDP) and earnings growth (EPS) will also be below the historical average. Future returns from the stock market are likely to be muted if (1) inflation remains stable and earnings grow slowly or (2) if inflation increases and drives P/E ratios lower. Strong stock market returns over the rest of the decade can occur only if P/Es expand further — against the laws of Financial Physics.

Updated
Through 2013

article: Financial Physics Executive Summary

Crestmont’s Research: Putting It Together 

Guests and clients often ask for a succinct explanation about how to tie together the various elements of research and perspective that are presented within Crestmont’s website. This executive summary represents an initial draft explaining, through a series of steps, the relationships among some of the research. Several of the charts within this website are referenced.

Updated
Through 2013

Financial Physics Presentation

Financial Physics 

This presentation introduces the core “Financial Physics” model. The key factors include Real GDP, Inflation, Nominal GDP, Earnings Per Share (EPS), and P/E Ratio. Since Real GDP has been relatively constant over extended periods of time and all other factors are driven by inflation, a primary driver of the stock market is inflation — as it trends toward or away from price stability. Given the current state of low inflation and the likelihood of it either rising (inflation) or declining (deflation), P/E ratios are expected to decline, in general, for a number of years. As P/E ratios decline and EPS grows, the result will be another relatively nondirectional secular bear market.

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P/E Ratio

Last Updated
Feb 6, 2014

Stock-Nightmare

Nightmare on Wall Street 

There is compelling evidence that the current secular bear market is still early in its course. This bear will likely have another decade or longer to run, unless over the next few years there is a dramatic change in the inflation rate that decreases P/E substantially. The preceding secular bull ended with the market valuation (P/E) at levels twice as high as all previous secular bulls. That meant that this secular bear had twice as much ground to cover. The last fourteen years have deflated the bubble, but the market still remains at levels consistent with secular bear starts.

Updated
Through 2013

Stock-Secular-PE

Secular Stock Market P/E 

The preceding secular bull ended with the market valuation (P/E) at levels twice as high as all previous secular bulls. That meant that this secular bear had twice as much ground to cover. The last twelve and a half years have deflated the bubble, but the market still remains at levels consistent with secular bear starts.

Natural Pinnacle To P/Es

Natural Pinnacle to P/Es 

Four reasonable inflation scenarios, a pragmatic analysis, and the standard dividend discount model explain why there is a natural (rational) limit to price/earnings ratios in the stock market. These scenarios reinforce the empirical evidence graphically presented in the “Y Curve Effect.” When inflation permeates the economy, it adversely impacts stock market returns. This analysis is complemented by “Financial Physics” and “The Yield Curve, The Fed, & P/Es.”

Updated
Through 2013

P/E Ratio vs. Dividend Yield

P/E Ratio vs. Dividend Yield 

The dividend yield of the stock market is relatively low by historical standards. Why? There are two reasons. Many studies present the first reason: corporations are paying a smaller percent of earnings in dividends. Historically, over the past century, the dividend payout ratio has averaged 35% to 60% of earnings. Today, the average payout ratio is near the low end of that range. The second reason, explored by this analysis, is that valuation directly affects dividend yields. As the price-to-earnings ratio (P/E) rises, the price-to-dividends ratio rises as well, thus lowering the dividend yield. This relationship presents another view of the market’s relatively high valuation.

Updated
Through 2013

P/E Ratios & Inflation

P/E Ratios & Inflation 

Conventional stock market wisdom has promoted a fundamental relationship between P/E ratios and interest rates. It has relied upon a key assumption that inflation is positive. As reflected in this chart, P/E ratios increase when the inflation rate trends toward price stability (near 1% inflation) and P/E ratios decline when the inflation rate trends away from price stability. The result is a “Y Curve” effect, where P/E declines into deflation despite low interest rates. This effect is consistent with the modern dividend discount model since earnings and dividends would be expected to decline during deflation and therefore would result in lower valuations.

The Truth About P/Es

Addendum Added
"About Every Five Years..."

The Truth About P/Es 

There has been no factor with a greater impact on the variability of investors’ returns over decade-long periods than the trend in the market P/E ratio. History shows that the change in the market P/E ratio over a decade often doubles or halves investors’ returns. This article and its graphs explain P/E, explore its history, and detail its implications. An addendum titled “About Every Five Years…” has been included to discuss periodic distortions in the P/E ratio (including the significant distortion in 2006 and 2007).

Updated
Through Jun 2014

The P/E Report

(periodic updates)

The P/E Report 

There are numerous versions of the price/earnings ratio (P/E), yet there are very few of these that can appropriately be compared to the recognized long-term average of 15. The objectives of this report are to detail the current level of the P/E ratio, to answer questions frequently asked about it, and to address the status of the current stock market cycle.

The P/E Report may be updated intra-quarter due to significant changes in the stock market and the impact of those changes.

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Earnings & Economy

Updated
Through Jun 2014

Stock-Earnings-Trend

(periodic updates)

Earnings Trends: History & Future 

This graph presents both (1) the historical trend for actual reported earnings per share (EPS), including a forecast by Standard & Poors, and (2) an inset graph presenting the historical record for S&P’s forecast over the past five years. To put the historical trend and future forecast into perspective, the graph includes Crestmont’s assessment of the long-term baseline trend for EPS. Crestmont’s baseline also puts into perspective whether current and forecast EPS are above or below the long-term trend for EPS.

Note: red dots are included with numbers that reflect the month number (e.g., 2=Feb.); this provides a view of the history of recent EPS forecasts. Also, the inset graph reflects S&P’s EPS forecasts for recent years; forecasts begin about two years in advance and proceed until the year is finalized.

Last Updated
Feb 6, 2014

document: Converging on the Horizon

Converging on the Horizon 

Beware: there are two series of short-term trends that are converging on their limits. Stock market history and earnings cycle history are converging. The goals of this updated article are (1) to dispel the notion that P/E is low today and (2) to highlight the risks of a decline in 2014 or soon thereafter.

document: Beyond the Horizon 2011

Beyond The Horizon: Redux 2011 

As of May 2011, profit margins were cyclically high, near historical highs, and already at unsustainable levels, with projected further increases over the next two years. Beware. Rather than rehash old ground, this article provides a speed-round of charts and limited commentary to explain conditions as of 2011 and the expectation for an earnings decline within the next few years. For the full explanation of the concepts relating to this article, please see “Beyond The Horizon: The EPS Cycle” and “Back To The Horizon: EPS Cycles Again,” immediately below. Once again, since the fundamental principles of the business cycle cause history to repeat itself, a decline in EPS should not be beyond your horizon!

Updated
Through 2013

chart: EPS Reality

EPS Reality 

The reality is that the business cycle is different than the economic cycle — GDP growth is much more consistent than EPS growth. It may surprise some to know that EPS declines can occur during periods of economic growth. Across the 64 years from 1950 to 2013, earnings declined — by 34% — during 22 of those years despite positive economic growth throughout the period. Real GDP growth (excluding inflation) has lagged the historical 3% average thus far in the 2000s and ’10s. But even if the economy looks solid for the next few years, history highlights that EPS is not immune to decline — especially from such currently high profit margins.

Updated
Through 2013

charts & analysis: It’s Not the Economy

It’s Not the Economy 

Despite the general contention that the economy and the stock market are inexorably connected, the facts get in the way of confirming common wisdom. This chart presents the average stock market return and average GDP growth by decade and by secular bull/bear market cycle. Economic growth is not the primary driver of stock market returns; instead, returns are driven primarily by a cycle in the P/E ratio (see the Secular Cycles chart above). Although economic growth does increase the denominator in the P/E (earnings), actual returns are generally the result of trends in the P/E ratio. This and other research that Crestmont has conducted dispels this conventional notion.

Last Updated
Dec 2008

document: Back to the Horizon

Back to the Horizon 

Earnings had been increasing at double-digit growth rates for five consecutive years from 2002 through 2006-although many agreed that earnings growth might be slowing, it was beyond almost everyone’s foreseeable horizon that earnings might actually experience a decline. Yet, before anyone knew it, the end of the cycle was in the rear-view mirror rather than beyond the distant horizon. This article is a follow-up to “Beyond The Horizon: The EPS Cycle” (located above).

chart: Beyond the Horizon

(revised with recent data; EPS graphs update)

Beyond the Horizon 

Earnings have increased at double-digit growth rates for five consecutive years — it’s beyond almost everyone’s foreseeable horizon that earnings might soon experience a decline. Despite the statistics about average earnings growth, the business cycle drives periods of surge and stall. This analysis explores the earnings growth cycle, the profit margin cycle, and then translates the outlook into specific implications for returns over the next decade. As an analogy, winter is not a time for farmers to hibernate; rather it’s a period to approach crops differently. Today’s investors have so many tools and techniques available to them to actively “row” and invest like institutions, thereby seeking relatively consistent returns with a lot less risk of disappointment.

Stock-Siegel-Shortfall

Siegel’s Shortfall 

Jeremy Siegel has criticized the validity of Robert Shiller’s version of the cyclically adjusted price/earnings ratio (aka CAPE and P/E10), especially following the earnings plunge in 2008.

While P/E & EPS may be distorted due to the 2008 earnings decline, the effect is no more than the offsetting distortion created by the periods of above-average profits on both sides of 2008. Recent record profit margins, coupled with the high profit margins before 2008, have fully restored CAPE EPS back to its long-term trend line.

Siegel can now start planning his future criticism of P/E10 for 2015 to 2018, when the Shiller EPS will experience a hiccup as the 2006-2008 period leaves the ten-year average.

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Market Volatility

Updated
Through Jun 2014

Stock-Volatility-Cycles

Stock Market Volatility: An Erratic Cycle 

By popular request, this chart of historical stock market volatility will be produced separately and updated regularly. It appears as a key graph in the article Volatility in Perspective.

This graph reflects a measure of stock market volatility–the statistical standard deviation of monthly changes for the S&P 500 Index. The line on the graph reflects volatility for each trailing twelve-month period starting in January 1951 and continuing with each month to present. There are several insights from the graph. First, volatility is volatile; it cycles erratically over time. Second, periods of extremely high or low volatility often follow the other. Third, volatility tends to spend most of its time around the average (i.e., within 25% above or below the average).

High or rising volatility often corresponds to declining markets; low or falling volatility is associated with good markets. The current period of low volatility is a reflection of a good market, not a predictor of good markets in the future.

Updated
Through Dec 2013

Stock Market Returns & Volatility

Stock Market Returns & Volatility 

This analysis presents an uncanny relationship between stock market performance and the volatility of the market. We do not assert a causal relationship; rather, the coexistence of the relationship implies that many measures of risk actually compound in declining markets. By contrast, the reward-to-risk relationship improves significantly in strong markets. In the context of secular bull and bear markets, this relationship further emphasizes the need to consider risk as well as reward in an investor’s investment decisions.

article: Calm Before the Storm

Calm Before the Storm 

In April 2005, “A Minsky Review” explored the risks and implications of low volatility in the markets. That analysis predicted an increase in market volatility by the end of 2006. One year later, as of April 2006, volatility had plunged further, into the lowest five percent of all periods since 1950. With numerous new and updated charts and graphs, this article explains that “the tectonic plates of the markets are intensely balanced in an edgy state of latent eruption.” Beyond presenting an assessment of current conditions (2006), this analysis, based upon the lessons of history, discusses the timing and implications of a reversal to rising volatility.

Minsky-Review1

A Minsky Review 

April 2005: Judging from the level of complacency in the stock market, some of you may not care to make it to the second paragraph of this article -— Hyman Minsky warned us about times like this! Those of you who stay until the end will find a compelling case that four indicators portend a significant decline in the stock market and a rise in volatility before the end of next year (2006). For those with financial exposure to the stock market today, you may be compelled to act. For those of you that have already hedged your positions, this article will provide the insights as to when to increase your exposure again. And for the complacent readers, save this for later reference to explain “why.”

Updated
Through Dec 2013

Volatility in Perspective

Volatility in Perspective 

Who or what is rocking the boat? Is the current level of volatility “normal” or is it extreme in either direction? The purpose of this presentation is to put volatility into historical perspective graphically. This report will be updated periodically as volatility is just too … volatile to be ignored.

Updated
Through 2013

Significant Swings

Significant Swings 

Although the compounded average annual change in the stock market is near 5% over the past century, the range of dispersion in annual returns is dramatic. This chart presents the distribution of yearly index changes within the single-digit range of -10% to +10% during the past century overall and during the secular bull and bear cycles. In addition, a second range was determined to include half of the years within the range and half of the years outside the range. More than 50% of the years ended with changes in the index exceeding +/-16% (either greater than -16% or greater than +16%).

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Investment Implications

Stock-Half-Half

Half & Half: Why Rowing Works 

This article addresses two key questions for investors today: why do secular stock market cycles matter and how can you adjust your investment approach to enhance returns? Secular cycles do matter, and the expected secular environment should drive your investment approach. The investment approach that was successful in the 1980s and 1990s was not successful in the 1970s nor over the past 14 years. Therefore, an insightful perspective about the current secular bear will determine whether you have the right portfolio for investment success over the next decade and longer. Now, assume for a moment that you must pick one of two investment portfolios. The first is designed to return all of the upside — and all of the downside — of the stock market. The second is structured to provide one-half of the upside and one-half of the downside. Which would you pick?

Last Updated
April 5, 2013

Article-Game-Changer

Game Changer 

MARKET BEWARE SLOWER ECONOMIC GROWTH

There are numerous perspectives about future economic growth. The latest tally includes about 1.5 opinions per economist (reflecting economists’ penchant for the phrase “on the other hand”). Some economists are more optimistic, others more pessimistic, and more than a handful position themselves on both sides of the fence. This article discusses the long-term implications for slower growth in the stock market. Whether your preferred economist advocates 2%, 1%, or 0% long-term growth, the outcome is similar in direction though varying in magnitude. The impact of near-stagnant growth will lie somewhere between bad and worse. Historically, the prospect of slower economic growth has not often been considered by economists and analysts, but it is now accepted in mainstream thinking. The implications of slower growth on stock market returns will be dramatic for investors.

Article-Looming-Crisis

Looming Crisis 

LOOMING CRISIS: STATE BUDGETS SOON TO BE UNDER SIEGE

Public employee retirement systems across the nation have a major problem. Almost all of these pension plans currently assume investment returns that are well beyond levels that are reasonably achievable going into the future. The result is that they appear better funded than they really are. Ultimately, the inevitable and substantial shortfalls that result will become the responsibility of taxpayers.

The current shortfalls are not, as conventional wisdom asserts, the one-time result of a stock market decline in 2008. The shortfalls are the result of the gap between faulty assumptions and actual returns, a gap which will ensure an ever-widening shortfall. Most policy makers assume that their recent provisions to address the shortfall will cure the problem over upcoming decades. Instead, the hole is many times larger than they believe. Some policy makers have even started advocating “reforms” that will burden the pension plans in order to fund programs outside of the plans.

There are significant implications for investors, taxpayers, plan beneficiaries, and other constituents. A wrongly-diagnosed problem leads to ineffective solutions and worsened conditions.

Row, Not Sail

Row, Not Sail 

For boatsmen, the history of rowing started more than 8,000 years ago; sailing is a relative newcomer, arriving on the scene about 3,000 years later. Likewise, for investors, the “rowing” approach to investing precedes the more modern “sailing” approach of passively buying and holding securities to realize the returns provided by the market. Crestmont Research and Ed Easterling brought together the two concepts as chapter 10 of Unexpected Returns, introducing the analogy that contrasts two vastly different investment approaches. The current secular bear market has driven investors and financial advisors to seek progressive skill-based absolute return investments, rather than to rely upon the more passive and traditional relative return investments. This excerpt from the beginning of the chapter summarizes the contrast. Investors, financial advisors, and money managers are welcome to use this analogy and this excerpt to foster a broader appreciation for the need to adjust investment strategy to the market environment (Of course, we hope that you’ll remember and recognize Crestmont Research in the process…).

Rowing vs. the Rollercoaster

Rowing vs. the Roller Coaster 

Why are so many of the most knowledgeable institutions and individuals shifting away from investment portfolios that have been concentrated in stocks and bonds toward a more diversified and risk-managed profile? The tools and resources are now available to permit investors at all levels to use this enhanced approach and be successful. This article describes the dynamics and benefits of seeking more consistent, absolute returns rather than investing simply for the relative returns of the stock market.

analysis: Impact of Rebalancing

Impact of Rebalancing 

“Row, Not Sail.” In strongly trending markets such as secular bull markets, the best strategy is to get fully invested and remain so. Let the profits and over-allocation in equities compound to your benefit. In choppy and volatile markets, an approach involving more frequent rebalancing can add significant additional return to an investor’s portfolio. Based upon recent secular market history, the risk (cost) of more frequent rebalancing in secular bull markets is far less than the opportunity derived from more frequent rebalancing in secular bear markets. Rebalancing is the active management technique that capitalizes on market cycles. Over-performance in one category (asset class) is shifted to another category to benefit from the second category’s later good performance.

article: Destitute At 80: Retiring In Secular Cycles

Destitute at 80: Retiring in Secular Cycles 

There has never been a thirty-year period for the stock market during which investors have lost money; yet there have quite a few thirty-year periods that have bankrupted senior citizens who were relying upon their stock portfolios for retirement income. Although history provides an average outcome across a wide variety of market conditions, it is relevant to consider only those periods with characteristics similar to those we see today. Given the significant impact of valuation on returns, valuation will be a major driver for today’s investors and retirees.

Updated
Through 2013

Up & Down Capture

Up & Down Capture 

A simple analysis–a powerful statement. What percent of the gains during positive months is needed to achieve stock market returns if an investor avoids losses during declines? Many “rowing” strategies, including hedge funds, are criticized for not getting much return during market declines and then not being able to beat the stock market on the upside. The answer: if an investor can avoid the losses, it takes only 27% of the positive gains to match the market. And, if losses are confined to 50% of the market drop, it takes only 63% of the gains to achieve market returns. So the main objective of “rowing” is to avoid the losses; the gains will seem to take care of themselves.

Updated
Through 2013

Up & Down Capture Graph

Up & Down Capture Graph 

The simple analysis -– graphed. Many “rowing” strategies are criticized for not achieving returns during market declines and then not being able to beat the stock market on the upside. The counter-argument: if an investor can avoid the losses, it takes only a fraction of the positive gains to match (or beat!) the market. So the main objective of “rowing” is to avoid the losses; the gains will seem to take care of themselves.

Portfolio Mismanagement

Portfolio Mismanagement 

If the first rule of portfolio management is diversification, why do most investors unwittingly concentrate their risks? Many investors believe that a portfolio constructed with numerous stocks and bonds is diversified. That approach has its roots in the principles of Modern Portfolio Theory (MPT). Yet when MPT is misapplied, it does not provide the roadmap to secure investing and leaves investors vulnerable to substantial risk. This article explores why the strategy of diversification in a portfolio should apply to risks rather than to securities. Most investors have unknowingly folded a significant concentration of risk into their investment portfolios.

article: Markowitz Misunderstood

Markowitz Misunderstood 

Harry Markowitz published his research titled “Portfolio Selection” in The Journal of Finance in 1952. He began the paper by parsing the portfolio selection process: “The process of selecting a portfolio may be divided into two stages. The first stage starts with observation and experience and ends with beliefs about the future performances of available securities. The second stage starts with the relevant beliefs about future performances and ends with the choice of the portfolio. This paper is concerned with the second stage.” In this article, we’ll consider the implications of the first stage, which is crucial to investors’ success in current market conditions.

The Impact of Losses

The Impact of Losses 

There is a very important reason that Warren Buffet’s “first rule of investing” is also the second rule: it takes a lot of gain to make up for losses. This graphic highlights a key lesson of investing.

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