Reasons to Avoid Buying Stocks, and Why You Should Ignore Them
THE NEW YORK TIMES, FRIDAY, FEBRUARY 22, 2013Reasons to Avoid Buying Stocks, and Why You Should Ignore ThemBy PAUL SULLIVANTHERE are always reasons not to buy stocks. Investors maythink the Dow Jones industrial average is too high, as was thecase in 1954 when the index topped 360. In 1941, there wasPearl Harbor. In 1962, the Cuban missile crisis. In 1997, theAsian financial crisis.The list, adding up to 78 for each of the years from 1934 to2012, was compiled by Bel Air Investment Advisors.But the punch line to this list was that stocks went up by anannual compounded rate of 10.59 percent over those 78 years,with occasional plateaus, and that $1 million invested in 1934was worth $2.4 billion in 2012.As for the last three years, the list singled out the Europeanfinancial crisis in 2010, the downgrade of United States’ creditrating in 2011 and the political polarization of 2012. Investorswere, in fact, generally reluctant to buy stocks. Yet in each ofthose years, stocks either rose in value or, at worst, were flat.The reason for such hesitancy is obvious. Investors are stillscarred from the 2008 crash and they perceive stocks as risky,a feeling reinforced by a good bit of volatility in the markets inrecent years. Yet as stocks rallied earlier this year, money fromindividual investors began to trickle back into equity funds.This could be good for an intrepid few.”The stock market is the same place it was in 2000 with doublethe earnings,” said Todd M. Morgan, senior managing directorat Bel Air Investment Advisors. “Stocks are set to outperformbonds over the next three to five years.”This may very well be true, but most people still think fearfullyabout stocks. What would it take to get more people to buystocks? And by this, I don’t mean going all in as investors didin the late 1990s, but creating some semblance of a balancedportfolio.Mr. Morgan and other advisers said that investors are beingmisled by talk about near-record levels for the Dow Jones andStandard & Poor’s 500-stock index today. When adjusted forinflation, the levels approached earlier this year are not truehighs. A new high for the Dow, for example, would be around15,600.What is more telling are the earnings and dividends ofcompanies. Niall J. Gannon, executive director of wealthmanagement at the Gannon Group at Morgan Stanley,calculated that the dividends on S.& P. 500 stocks were $15.97in 2000 and $31.25 in 2012. Earnings per share were $56 in2000 and $101 in 2012. In other words, two major measuresof a stock’s attractiveness have doubled in the last 12 years,but the index has not kept pace.”A big mirage is going on in investors’ minds,” Mr. Gannonsaid. “They think stocks are expensive because they’ve usedindex levels as the measure.”And investors aren’t confident that stocks will continue torise, given the volatility in recent years. They may well fallin the short term, but over the next few years they are morelikely to give investors a better return than bonds. Mr. Gannonpointed to an earnings yield on the S.& P. 500 of around 7percent.But these are rational arguments for individual companies.They do not account for concerns that the actions of theFederal Reserve have skewed stock prices, another rationalfear.Michael Sonnenfeldt, the founder of Tiger 21, an investmentclub whose members each have at least $10 million to invest,said the feeling from the group’s annual conference was thatthe 14,000 level on the Dow was worrisome because it couldbe the result of all the money the Federal Reserve has put intothe system and not based on company fundamentals.The group, he said, was also worried that the Federal Reserve,having kept interest rates artificially low for so long, couldhave created a situation where investors suddenly demandhigher interest rates at a government bond auction. A crisislike that could lead to deflation, and not inflation – wherestocks are considered a hedge.What’s telling is that TIGER 21 members reported increasingtheir allocation to equities by 3 percentage points in the lastsix months. “It’s not a stampede,” he said. “The focus hasbeen on dividend-paying stocks, not growth stocks or techstocks.”For people with far less than $10 million to invest, the catalystto buy stocks will probably be losing money in the bonds theyown. “Over the last three years, you’ve lost out not being instocks,” said Bernie Williams, vice president of discretionarymoney management at USAA Investments. “But you still mademoney in bonds. From that perspective, investors are not reallyfeeling the pain.”There is an alternative view, of course, that says the unwillingnessof people to invest in stocks now is completely normal and thatwhat happened in the 1990s with stocks and in the 2000s withreal estate were anomalies, at least for average investors.”The alternative to investing or saving is spending today andthat is always infinitely more pleasurable,” said Don Phillips,president of investment research at Morningstar. “Throughoutthe ’80s and ’90s, you had this amazing bull market and it gaveyou this immediate gratification that usually only spendinggives you. Now we’ve been through a more realistic period,and people realize that is not always the case. The reward isdeferred, and there may be severe losses.”Mr. Phillips noted that if people were able to pick a winningstock 55 or 60 percent of the time, they would be remarkablysuccessful. But in spending money on something they wanttoday, their success rate is automatically 100 percent.”I think for a mature American adult, investing should be anexpectation,” Mr. Phillips said. “So much of the discussionaround the recent tax increases is that investing is somethingonly the 1 percent does. That fuels this mind-set that makesinvesting seem unrealistic for most people.”Greg B. Davies, head of behavioral finance at Barclays Wealthand Investment Management, said people could persuadethemselves to increase their allocation to equities by joining investment clubs where the group, in theory, would be betterat making a decision that was painful. People could alsoslowly buy the stocks they want, a process called dollar-costaveraging.”The classical economics position on all of this is that it isirrational and you should ignore it,” Mr. Davies said. “That’snot very helpful advice. We do have an emotional response.”He said he would instead encourage average investors toforget about maximizing their risk-adjusted returns and aimfor their “best anxiety-adjusted returns.”For those with more fortitude, the simplest solution is totake the long view – as in 10 or 20 years, which is a lot ofdelayed gratification.”Whenever you’re having a discussion like this, timehorizon is a key consideration,” said Bill Stromberg, head ofglobal equities at T. Rowe Price. “Most investors have beenconditioned to think the next six to 12 months out. It’s toohard for anyone to predict what’s going to happen then.”And while no one I spoke with expected stocks to return todouble-digit returns year after year, a simple argument couldbe made for a return based on a dividend of 2 percent andearnings growth of 5 to 6 percent.”That’s not a home run for anyone, but it’s better than you getin bonds,” Mr. Stromberg said.It is entirely possible that stocks will lose value across theboard this year or the stocks you pick will fall significantly.But that is why every adviser stresses diversification and along view. What matters is how a portfolio’s returns look ina decade or two, not tomorrow.