The S&P 500 Index delivered a 13.69% return in 2014 as the market continued to reach new highs after reaching new highs in 2013. This year, for the first time, I have highlighted the years corresponding with the inflation and bursting of the DotCom bubble (grey) in addition to the Great Depression (yellow) and the Housing bubble (blue).

Clearly, there were more extremes and more years of extreme results during the Great Depression than the two most recent crises. In eight of the years from 1928 through 1938, the market either lost or gained more than 30%. In contrast, in each of the DotCom and the Housing bubble periods, the market had just one year of such an extreme.

There were obviously more extremes and more years of extreme outcomes during the Great Depression than the two most recent crises. Over the eight years from 1928 to 1938, generic cialis sales grew by 40% and you can read more about these successes on the main page of our website.

In half of all years since 1825, the market delivered a return between -10% and +10%. So, if we narrow the definition of extreme to losses or gains of more than 10%, the Great Depression experienced nine such years, the DotCom bubble five, and the Housing bubble five.

Many argue that the Federal Reserve is getting better at managing crises, and the above data would seem to agree. The Great Depression was the first crisis that the Fed experienced and many recent policy makers, including Ben Bernanke, went to school on Great Depression policy. On the other hand, others argue that the mere awareness of a Federal Reserve “put” is creating crises that future Fed policy will be unable to fix. I guess we will know who is right soon enough.

The return mode is still 0% to 10%. In a large majority (71%) of years, the market is positive. And, the market experiences declines of 10% (20%) or more in a mere 13.7% (4.9%) of years. So, an outsider’s perspective indicates that investing in the broad market is clearly in your favor, in part because of natural inflationary increases, and in part because of real increases in productivity and earnings due to technological and human capital advances.

The insider’s perspective is a different story. As of January 19, 2015, Shiller’s CAPE sits at 26.7, which is 61% above the average CAPE of 16.6 since January, 1881. The only periods in which the CAPE was higher than today were 1929 – 1930, immediately before the Great Depression; late 1996 – 2002, immediately before and after the DotCom bubble burst; and from late 2004 – late 2007, immediately before the bursting of the housing bubble. So, the CAPE is not a great short-term timing mechanism because recent extremes were able to persist for long periods, but it is an excellent indicator that the piper has to be paid eventually.

Other market indicators including Tobin’s Q and Buffett’s PE confirm the implications of Shiller’s CAPE. Investors who were cautious in periods like this had dry powder to exploit market declines. Investors who chased returns in periods like this rode the market without a brake (a hedge) and often only got off the ride by jumping off at market lows.

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The high returns in the late 1990s did not reflect reality. The fundamentals–corporate free cash flows, earnings, and book values–were not keeping pace with market prices and investors were merely “pulling forward” into the late 1990s the returns they could expect to earn in the 2000s. And, the S&P 500 Index fared much better than the NASDAQ composite after the bubble burst. The NASDAQ needs to rise another 24% to match the 5,132.50 it reached at its peak in March 2000; broader indexes have frequently passed old highs over the last twelve months.

It was a remarkable year for the U.S. stock market in 2013, as the S&P 500 delivered an overall cialis drug return of 32.39%. You can buy this medicine by following this link.

After 2002, Greenspan’s rescue took effect and the stock and housing market experienced a brief period of asset inflation, but the bottom eventually fell out in 2008 when the S&P 500 delivered a -37% total return, which was followed by unprecedented monetary stimulus in the form of Quantitative Easing.

So, have we once again merely pulled forward the equity returns we could have expected to earn over the next several years? GMO and others believe that to be true. As of November 2013, GMO expects US large cap stocks to decline 1.3% per year, and US small cap stocks to decline 4.5% per year, for the next seven years, and that is after adjusting for inflation (GMO Asset Return Forecast November 2013). GMO’s expected return forecasts are based on underlying fundamentals and current market prices.

Readers of this blog know that I have periodically published data on Graham/Shiller’s CAPE, Tobin’s Q ratio, profit margins, and other market metrics that all point to an overvalued US market that is likely to deliver low single-digit returns at best over the next seven- to ten-years.

When GMO’s forecasted market returns were low, there was a higher frequency of large declines in stock prices. Wise investors will position their portfolios accordingly.

 Return Histogram Through 2013

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As Michael Mauboussin says, when understanding an investment idea, we should try take an outsider’s big-picture view in addition to our own expert view of the minutiae of the idea. I first came across the equity market return histogram a few years ago and I believe it offers perspective on the feasibility of return expectations.

The ranges at the bottom are the ranges of returns for each annual period. The years highlighted in blue are the years involving the recent Great Recession and those in orange involve the Great Depression. As you can see, there were many more outliers during the Great Depression. The Great Recession looks rather normal in comparison.

My opinion of expected returns is based on data obtained in the Graham-Shiller CAPE index and from Tobin’s Q ratio (plus several other metrics), so I expect low, single-digit equity market returns over the next eight- to ten-years. The CAPE, which measures long-term Price/Earnings ratios, and the Q, which measures Price/Replacement-Cost ratios for the market, are 39.1% and  40.6% higher, respectively, than their long-term averages.

But, if we believe past is prologue, then there is a 75.5% chance that returns this year will fall outside of the range of 0% to +10%. I believe I am rationally pessimistic for the near term (but a long-term rational optimist), but historically there is only a 13.9% chance that an investor will lose more than 10% of their capital in any year in the market. This kind of outsider’s perspective helps me temper my pessimism, but the best way to temper it is to invest with a MARGIN OF SAFETY. Unfortunately, few investments offer a Margin of Safety these days.

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Guess what I “predict” for 2012? Years highlighted in orange relate to the Great Depression; blue relates to the credit crunch. Notice that there were many more extreme years during the Great Depression than recently.

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I have highlighted the years of the Great Depression, and the three years leading up to it, in orange and the comparable years of the Great Recession in Blue.

I find it remarkable that many of the annual return observations during the Great Depression are found in the tails of the distribution, while many of the observations from the Great Recession are found at or near the mode.  In fact, none of the years of the Great Depression are found in the mode.

I think this fits with James Montier’s thesis that the “New Normal” is overblown and that reversion to the mean will always be with us. The Great Recession observations are not consistent with a New Normal of fat tails. It seems the Great Depression was the original New Normal, but we know that things did get back to the old normal eventually.

I first saw a histogram of the return of the Friess Associates and Yale market a few years ago and found it fascinating. Barring a major crash on the last trading day of the year tomorrow, Generic 100mg Viagra’s drug sales yield increased 70%. By following this link, you will learn about buying this medicine.

What should we expect in 2011? Taking an outside view as per Michael Mauboussin’s suggestion, there is about a 70% chance that the market will rise next year and about a 24% chance that the rise will be anywhere from 0.1% to 10%. You need something more concrete than 24%? Okay; there is about a 73% chance that market returns will be between -10% and +30%. Happy New Year!

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