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Some market history: buy and hold -vs- buy on dips -vs- buy when things are good

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May 18, 2009 – Comments (5)

So the dow jones industrial average shows 300 in october 1928 for its starting date.

Today it hows 8300 or so.  Thats a little over 80 years, and you have about 28 times your money.  The annualized return is 4% per year. 

The S&P 500 chart starts in 1950 at 17.3.  59.4 years later its yielded about 7% per year.  So buying the S&P 500 in 1950 and holding it until today was hardly a bad investment.  It must have beaten inflation and created real wealth for you.  Thats good.  100 bucks into the S&P in 1950, buy and hold, would $5,000 today.

Focusing on the S&P and not on the DOW, because I think the Great Depression is a historical phenomenon that isn't likely to be repeated today.  I know some of the mega-bears here on CAPs would disagree, and the intent of this post isn't to argue over whether the US is going to end soon, its to make a point.  To explain the whole reason why I got in this market.  Why I haven't considered it risky if you have a long time horizon, and all of that.  A history lesson is all we have here.

Lets say that you played it perfectly.  Buying stocks at dips, selling stocks at high points.  You start with $100.  You buy in 1953 with the S&P at 22 because the market hasn't been up in several years, you sell in 1957 for 44.  You now have 200 bucks.  You buy back in in 1958 because stocks have both dropped alot (nearly 20%) and not gone up for several years.  In at 40, out at 70 in 1962.  Now you have 350 bucks.  The market crashes shortly thereafter by about your 20% target, so you buy back in at 55 in 1964, you sell for 90 in 1966.  550 bucks.  The market then crashes by your 20% target to the 70's, so you buy in, sell when it recovers 50% in a couple years.  Now you have about 800 bucks.  You buy into the huge 1974 dip for 70 and sell for 105 a few years later.  1200 bucks.  Your 20% criteria is met again in 1982.  You average in for 110, sell 4 years later for 220.  2400 bucks.  Black monday meets your criteria in a single day, so you average in for 250 and sell 12 years later for 1400.  now you have almost 14,000 bucks.  The market then crashes its pants off again in 2002, so you average in for 1400 ish in 2007.  Now you have 22,000 bucks.  4.4 times the amount you had by buying and holding if you bought ONLY into little dips.

But this is conservative, very conservative.  Because you could have made about 3 or 4 or 5% in the time you weren't in the market in gov't bonds or bank CD's or something.  So combining a "sit around and collect interest in between big market crashes" strategy would probably have left you with 25,000 bucks or 5x the return of buy and hold.  Thats 10%/year. 

Nobody, of course, can get in right at the bottom of all those dips and sell at the top, and I sure as heck can't. 

But what I'm trying to say is that, historically, if you just bought into big market crashes and then went away once everybody felt happy and thought buying stock was safe again, you'd be way, way, way, way, way ahead. 

Now, combine that with the methodical buy-cheap stocks approach that David Dremman has shown beats the crud out of the market (simply buying blindly into the lowest quintile for p/e or p/b or p/s or p/yield has beat the market majestically from 1970 through 1996).  Over this period the lowest quintile of p/e yielded 19%/yar (counting dividends).  The highest quintile for p/e yielded 12% and the market yielded 15%, 

For price/cash flow it was 18% for the lowest quintile and 11% for the highest.  Price/book 19% for the cheapest 1/5th of stocks, 12% for the most expensive.  On and on. 

So imagine if you

1.  only bought cheap stocks, never chase a shooting star, never buy a stock that doesn't mean Dremmans dartboard demonstration that cheap stocks win

2.  only bought during big market crashes, and sold after the market rallied 50% or 65% or whatever from its lows.  Let everybody else enjoy a long bull market if they insist. Always leave some money on the table for the next guy

You, per these demonstrations, might now be up on the market by 3% (only buy in crashes and go away thereafter) and 4% (only buy cheap and go away thereafter) or 7%.  Now in those same 59 years you'd have about $100,000. 

And remember, probably (certainly this bear market has this as true if you look at forward p/e.  alot of the companies with bk risks associated with them have had stunningly low forward p/es, sometimes below 1) the lowest quintile of P/Es has alot of the companies that are going to go broke.  So does the highest quintile of course (if E is negative).

So just imagine that you were able to sift through the ashes and greatly reduce the odds of buying a company that goes broke via due dilligence.

All i'm tryin gto say folks is that my investment strategy is based on these assumptions

1.  I am very dumb.  I cannot see the next move of the market and I don't know what tomorrow brings.  I am very dumb.

2.  I am very dumb.  i cannot know what great trend is going to happen next in society, i can't see the future, I don't know who the next microsoft is, I don't know what drugs will get approved and what drugs won't

3.  I am very dumb, I cannot possibly be smarter than history.  so

4.  I'm just planning to play the historical odds. 

4a) Buy into big market crashes, sell when the market is 50% off its lows (or at least seriously hedge then or start averaging out)

4b) Buy stocks only with the upside premise of "they are far too cheap, they are worth more than this", never buy into a growth story on the logic that "its gonna be HUUUUGE"

4c) Make some nice boring interest in between market crashes. 

So...  following these boring tales...  I guess S&P 1000-1050 is my exit point. 

Bears make money (until the bear market ends anyway), and bulls make money (until the next bear market anyway), but pigs get slaughtered.  I am not sticking around to see if the market gets back to 1500.  I'm following my basic rules as outlined above and thought about while tyipng this post.

If Doug Kass's prediction that the S&P challenges 1000 sometime this year, after a monster correction here, comes anywhere near true, I'm taking a total hedge and calling it good. 

5 Comments – Post Your Own

#1) On May 18, 2009 at 3:31 AM, portefeuille (99.60) wrote:

The annualized return is 4% per year.

... and just ca. 2% between 1885 and 1995 for the "real" (vs. "nominal") Dow Jones index (see here!) which of course looks like a "disaster" until the dividends (!) enter the picture ...

(some long-term charts)

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#2) On May 18, 2009 at 4:15 AM, portefeuille (99.60) wrote:

Lets say that you played it perfectly.  Buying stocks at dips, selling stocks at high points.  You start with $100.  You buy in 1953 with the S&P at 22 because the market hasn't been up in several years, you sell in 1957 for 44.  You now have 200 bucks.  You buy back in in 1958 because stocks have both dropped alot (nearly 20%) and not gone up for several years.  In at 40, out at 70 in 1962.  Now you have 350 bucks.  The market crashes shortly thereafter by about your 20% target, so you buy back in at 55 in 1964, you sell for 90 in 1966.  550 bucks.  The market then crashes by your 20% target to the 70's, so you buy in, sell when it recovers 50% in a couple years.  Now you have about 800 bucks.  You buy into the huge 1974 dip for 70 and sell for 105 a few years later.  1200 bucks.  Your 20% criteria is met again in 1982.  You average in for 110, sell 4 years later for 220.  2400 bucks.  Black monday meets your criteria in a single day, so you average in for 250 and sell 12 years later for 1400.  now you have almost 14,000 bucks.  The market then crashes its pants off again in 2002, so you average in for 1400 ish in 2007.  Now you have 22,000 bucks.  4.4 times the amount you had by buying and holding if you bought ONLY into little dips.

You forget to mention the dividends (see this) ...

 

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#3) On May 18, 2009 at 8:56 AM, Entrepreneur58 (36.29) wrote:

When prices fall, future return goes up, assuming your investment survives to see the next cycle.  When prices rise, future return goes down.    Most people, however, will invest in the thing which has been going up the most and thus has the lowest future returns (hence the "greater fool" theory).

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#4) On May 18, 2009 at 9:16 AM, Gemini846 (49.62) wrote:

When people quote the return of the S&P they usually do include the dividends. His argument is that he can supplant the div income by putting the money into bonds.

But this is conservative, very conservative.  Because you could have made about 3 or 4 or 5% in the time you weren't in the market in gov't bonds or bank CD's or something.  So combining a "sit around and collect interest in between big market crashes" strategy would probably have left you with 25,000 bucks or 5x the return of buy and hold.  Thats 10%/year. 

Of course you have to time the market right on your bonds, but if the economy is roaring the yields should be higher and vice versa.

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#5) On May 18, 2009 at 9:21 AM, Seansonfire (38.64) wrote:

Your analysis does not even take into account Dividends which would push you up even higher.  The S&P usually has a yield anywhere from 1% up to 4% so you can average it around 2.5% a year.

 That would make a big difference over time.

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