Talking Points

Recovery Reality Mark Zinder Action Shot

If past performance is not an indication of future results then why does history keep repeating itself with alarming regularity?

There are early indications that the economy is in the beginning stage of a recovery. This, of course, will not be confirmed for months to come. For entertainment purposes only, let's conclude that the positive news, recognized as nominal, is correct and this current recession is over and we are witnessing the early stages of an improving economy. Using these assumptions, its length measured in months would total sixteen, coincidently the same length we experienced during the recession of 1973/1974. On average, post World War II, each recession has lasted 10 months and the DOW has taken four years and four months to return to its previous high; the notable exception would be The Great Depression. Historians are quick to point out that it wasn't until 1954, 25 years later, that the market finally surpassed the heights it had reached in 1929.

Throughout the 1970's, the markets as measured by the DOW went absolutely nowhere. DJIA didn't flat line, it had its ups and downs, but it ended where it started: 838.[1] December 31, 1970 the DOW stood at 838. December 31, 1979 the DOW was at 838. In parallel, I believe the last time the DOW topped out at 8,400[2] was roughly eleven years ago. It is also interesting to note that the S&P lost 48% of its value in the correction of 1973 and 1974, almost matching not only the decline the S&P experienced from 2000 to 2002, but also the one we are currently experiencing.

From the early 1950's until the mid-1960's we witnessed an economic expansion that was at the time the longest in recorded history, lasting 107 months. Then the 1990's recorded an economic expansion that lasted 120 months. During each of these two periods the market's annualized rate of return was roughly 18%.

But this time it's different. (The very words John Templeton claimed to be the most dangerous in our industry.)

Never before have we seen the collapse of a banking system that it is considered by many, to be one of the most stable in the world. That is, unless, you include the banking crises of 1907. That year the market decline as measured by the NYSE was down 37% (the S&P index wasn't created until 1926). Last year, the S&P was down, you guessed it, 37%.[3]
For many, the only comparable period to this one existed 7000 miles away in Japan during the 1980's. The Nikkei's decade-long bull market conveniently ended in December of 1989. That month saw Japanese stocks selling at 5 ½ times book value, valuations reached never before. In 1999, the US markets were selling at 6 times book, also valuations reached never before. The Japanese market correction has now entered its 19th year with a total decline of 82%. The NASDAQ, peak to trough, was down 78%. In the early '90's, real estate in Japan was sold by the square inch. The real estate that the Imperial Palace sat on was said to be worth more than the entire state of California. Real estate in California today . . . well, you get the picture.

We begin to ask ourselves: Are we living through what may be a 19-year, Japanese-style economy or, even worse, one that is comparable to The Great Depression?

The issue with the original statement is that past performance is not indicative of future results. Within the commonalities there are always the lurking differences. That is our job: to find the hidden disparities; to look beyond the obvious to find the opportunities.

Is it possible that our economy and market will be like that of Japan's? Or even worse, it will last 25 years as the Depression did? For the sake of discussion, since we have pointed out the similarities, let's now point out the differences.

Japan's population is aging faster than ours and is barely growing. From 1980 to 2008, Japan's population grew by just 9%. In the U.S. during the same period, our population has grown by 34%. Not included in our population growth are net new immigrants of nearly five immigrants for every 1000 Americans vs. zero for Japan.[4] They also depend on exports to grow their economy rather than personal consumption which makes up roughly 72% of our economy. Japan has always been a nation of savers, which is, because of their extended period of deflation, to their detriment. "Why buy it today when it will be cheaper tomorrow?" By increasing the money supply we have accomplished two things: we have stimulated the economy and we have kept the economy out of deflation.

It is important to recognize these differences rather than the similarities primarily because it is these distinctions that differentiate this recession from The Great Depression.

Similar to Japan's period of deflation, the United States experienced the CPI falling 18% from 1929 to 1936 which exaggerated the market's decline.[5] Many of us know that market returns are made up of mainly two components; equity appreciation and dividend yield. However, dividends are not calculated into the DOW's total return. If they were, the DOW would not be at 8,400 but well over 750,000. As investment advisors, we are accustomed to yields historically averaging roughly 4%, however Robert Shiller notes that the dividend yield in the early 1930's was closer to 14%.[6] Lastly, Norman Fosback makes a great point when he mentions in his newsletter, Fosback's Fund Forecaster, that Dow Jones and Company decided to remove IBM from the list of the 30 stocks that made up its index in 1939. It was added back in 1979. Since that one stock greatly outperformed the DOW index in the 1940's, Mr. Fosback estimates that the DOW would have been twice as high in 1979 had it remained in the index during that 40 year period.

What if one went back and recalculated the length of time it would have taken the DOW to recover using the three additional measures mentioned above, how long would it have taken the DOW to recover? According to Ibbotson Associates: four years and five months or, very close to the historical average of four years and four months.

Maybe history doesn't repeat itself, but to ignore it would be a considerable misstep.