Molehills out of mountains

December 21, 2009 in General

The WSJ has crunched the numbers and concluded that:

In nearly 200 years of recorded stock-market history, no calendar decade has seen such a dismal performance as the 2000s.

Investors would have been better off investing in pretty much anything else, from bonds to gold or even just stuffing money under a mattress. Since the end of 1999, stocks traded on the New York Stock Exchange have lost an average of 0.5% a year thanks to the twin bear markets this decade.

I think the authors should have stopped right there, scratched their heads and wondered how the words "twin bear markets" and a tiny loss of just 0.5% a year could appear in the same  sentence. But they did not, they plowed on with such statements as, "From 2000 through November 2009, investors would have been far better off owning bonds."

The answer, of course, was a bubble-fueled bull market of low volatility and cheap credit coupled with a decade of unprecedented volatility in general. If we assume for a moment that instead of being a horde of mindless idiots, investors are shrewd market timers, they could have returned 100% just by buying the S&P 500 basket from 2003 to 2007. They would have had not one but two ("twin") opportunities to reap the same profit shorting the market in 2001 and 2008.

This is why the exercise of boiling arbitrary time periods down to a first order statistic - the average return - is such a meaningless exercise if performed without context. It fails to capture the full texture of the decade - the ups, the downs, the in-betweens. The richness and texture of the last 10 years are to some extent by the S&P's chart. It's not useful, instructive, or even a proper comparison to compress the decade. Show me an investor who purchased the index at the start of the decade and hasn't traded since, and I'll show you someone who actually might find long term bonds a more suitable alternative.

The second order measure is the real story of the decade: in 2008, the VIX hit 80!! And as late as January 2007, it was under 10!

But enough with the decade retrospectives, with the sensationalist headlines comparing this decade's average return to that of the 1930's (here's a hint: Black Friday was in 1929). You want a story? Focus on the twin bear markets - look at how amazing it was that you could have two in such a short span and still only lose 0.5% a year on average!

But the next time I find someone who only invests on January 1 of years ending in zeros, I'll be sure to pass this along.

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