Archives For July 2010

I have been keeping a spreadsheet with the total monthly returns for the S&P 500 Index going all the way back to January, 1926. NOTE: Prior to February, 1957, the S&P 500 was the S&P 90. With the possession of these returns, I am able to do all sorts of fun stuff.

What inspired today’s post was a comment from AFM reader, BG, on this post. The comment:

“As for DR’s 12% claim: it’s a worthless number. But the same case could be said of JLP 9% claim: just because we have seen a long-term historical rate of about 9% yearly (who invests for 84-years anyway), doesn’t mean that the market will perform considerably below 9% into the foreseeable future. Past performance IS NO GUARANTEE of future returns.”

BG’s comment got me to thinking…

He’s right. We don’t invest for 84 years. We do, however, invest for 10, 20, and 30 years at a time. So, I created a new spreadsheet, copied and pasted my S&P numbers, and performed some new calculations using rolling-period returns. For those of you who don’t know what I mean by “rolling-period returns,” the returns are calculated on a rolling-basis. For example…

To calculate one-year rolling period monthly returns, I took the first 12 months of 1926 (January through December) and calculated the geometric return for those months. Then, I performed the same calculation using returns for February 1926 through January 1927. I simply copied and pasted my formula until I had returns for all the one-year rolling periods through 2009.

For this post I concentrated on 10, 20, and 30-year rolling periods since those are long-term investment periods. I ran the numbers and then computed the geometric average, median, highest, and lowest returns. I then put that information into the following tables:

The worst 10-year period ran from September 1929 – August 1939. The best was June 1949 – May 1959.

The worst 20-year period ran from September 1929 – August 1949. The best was April 1980 – March 2000.

The worst 30-year period ran from September 1929 – August 1959. The best was July 1970 – June 2000.

It’s important to note that these returns do not include inflation or any sort of fees (since they are index returns). Actual returns would have been lower than these—depending on fees and tracking error.

I have a couple of follow-ups planned for this post. Stay tuned…

Scroll down to get a special code for AFM readers to get $20 off the series.

I received an email late last week from Larry Winget, alerting me to a new video series he is offering called “Unfiltered Truth.” The series is composed of 12 videos on the following topics:

• Turn Your Life Around

• Business

• Selling

• Problem Solving

• Life

• Success

• Goal Setting

• Leadership 1 & 2

• Relationships

• Customer Service

• Money

I posted a snippet of one of his videos in the series last week. In case you missed it, it’s this one:

Larry was kind enough to provide me with a special code (LHW2010) for AFM readers, which will allow you to get $20 off the purchase of the series. To order the series, go to Larry Winget Truth Series and follow the order instructions. There will be a place for you to insert the code.

Oh, and in case you were wondering, AFM does not get a cut. I’m simply doing a favor for a friend.

It’s a good series. I watched the episode on business earlier tonight. Larry gets to the point but also adds some humor. Good stuff.

I didn’t add “OT:” to the beginning of the title because this one is money-related…lol.

Here’s a little Monday Morning Humor for you. You can thank my wife’s grandmother, who sent this one to me.

A Cowboy from Sweetwater, Texas walked into a bank in New York City and asked for the loan officer. He told the loan officer that he was going to Paris for an international rodeo for two weeks and needed to borrow $5,000 and that he was not a depositor of the bank.

The bank officer told him that the bank would need some form of security for the loan, so the Cowboy handed over the keys to a new Ferrari. The car was parked on the street in front of the bank. The Cowboy produced the title and everything checked out. The loan officer agreed to hold the car as collateral for the loan and apologized for having to charge 12% interest.

Later, the bank’s president and its officers all enjoyed a good laugh at the Cowboy from Texas for using a $250,000 Ferrari as collateral for a $5,000 loan. An employee of the bank then drove the Ferrari into the bank’s private underground garage and parked it.

Two weeks later, the Cowboy returned, repaid the $5,000 and the interest of $23.07.

The loan officer said, “Sir, we are very happy to have had your business, and this transaction has worked out very nicely, but we are a little puzzled. While you were away, we checked you out on Dun & Bradstreet and found that you are a highly sophisticated investor and multimillionaire with real estate and financial interests all over the world. Your investments include a large number of wind turbines around Sweetwater, Texas. What puzzles us is, why would you bother to borrow $5,000?”

The good ‘ole Texas boy replied, “Where else in New York City can I park my car for two weeks for only $23.07 and expect it to be there when I return?”

This week’s Carnival of Personal Finance is hosted by NerdWallet. Stop by and check it out.

I emailed Dr. Robert Wright, Nef Family Chair of Political Economy at Augustana College SD, and author of numerous books (see post below), to get his take on the financial reform bill that is about to become law. As you can tell from the title of this post, Dr. Wright is not pleased with the legislation. Please take a few minutes to read Dr. Wright’s thoughts and leave a comment with your thoughts or questions and I’ll see if I can get Dr. Wright to respond.

Thanks for another opportunity to reach out to your audience. The last time I posted on your blog, One Nation Under Debt* was gaining traction as the national debt soared under the strain of numerous Bailouts*. This time, my Fubarnomics* is hot off the presses and the U.S. economy looks as “fouled up” (ahem!) as ever. Our construction, higher education, healthcare, and retirement savings industries are as stagnant as ever, acting like huge millstones around the economy’s neck. Alan Greenspan calls this an economic “pause” but I fear the problems run so deep that we’re headed for a Japanese-style stagnation that could last for decades. And I despair that our policymakers in Washington lack the intelligence, knowledge, and incentives to initiate major improvements. All three are needed and the last two are largely lacking.

For example, the financial reform bill about to become law is, like most post-crisis financial regulation, a problematic piece of legislation. As currently constituted, it will not, and indeed cannot, prevent future financial crises. Like many a failed general, Congress has prepared to fight the last war rather than the next one. The legislation will help incumbents up for election this fall by creating the appearance that Congress is “doing something” and by tossing sops to ideologues, mostly on the Left. It does precious little, however, to address the core cause of financial crises, the ability to take one-sided bets.

Almost every financial crisis in U.S. history was preceded by a bubble where the price of one or more assets – sometimes land, sometimes financial securities, sometimes commodities, sometimes all three – soared well above their fundamental value for an extended period. That isn’t supposed to happen in rational markets but it does anyway for a variety of reasons, including leverage. If speculators can borrow on the collateral of the over-valued asset they will do so with alacrity because it allows them to make one-sided bets. If the price increases, they sell, repay the loan, and keep the difference. If the price drops, they give up the asset and walk away.

The question then becomes why do lenders make loans to speculators on such terms? Why, for example, did banks make non-recourse mortgages, i.e., loans where the collateral (the house) backed the loan but not the borrower’s other assets or future income? The answer is another one-sided bet, this time within lenders. In large financial institutions, most compensation is asymmetric, “performance”-based, and tied to peer benchmarks. In other words, employees get big bonuses for exceeding the numbers put up by competitors but don’t suffer losses when things go bad. During bubbles, therefore, they feel pressure to lend freely even if they have reservations about long-term loan quality.

Lenders’ owners (stockholders, partners) sometimes recognize the risks involved in lending to bubble speculators and decide to proceed anyway. Little can or should be done about that. More often, however, stockholders are not aware of the risks they are being exposed to because managers have incentives to hide them. Remember, managers receive enormous bonuses in big years but do not have to pay those bonuses back during lean ones. They therefore want to take on far more risk than most stockholders do, but under our current, watered-down system of corporate governance stockholders have little say in management and very poor information about company operations.

The financial reform legislation really falls down at this crucial juncture.(Like 99.99999% of the population I haven’t read the entire 1,000+ page bill but rather rely here on the Senate banking committee’s final summary.) Instead of providing stockholders with an indisputable right to decide how their employees will be compensated, the new law gives them only a “say on pay” including the “right to a non-binding vote on executive pay.” Compensation now will be decided by committees composed of “independent directors” empowered to hire compensation consultants. That sounds great on paper but fails to capture the complex realities of corporate boardrooms where manager-directors often dominate or co-opt other directors, rendering them a far cry shy of “independent.” To end the long-lived tyranny of the managers, we should return to early nineteenth century rules: no directors should be in management and stockholders should have the final say on everything.

The balance of the new legislation exhibits typical statist thought and assumptions. “The Madoff scandal,” proclaims the summary, “demonstrated just how desperately the SEC is in need of reform. The SEC has failed to perform aggressive oversight and is unable to understand some of the very companies it is supposed to regulate.” Then why reward it with more powers and a bigger budget? Why not tell investors that they are responsible for their own money? That, combined with the empowerment of stockholders discussed above, would work wonders because to obtain funds securities issuers and institutional investors would have to display much more transparency, at least on a selective basis, than they currently do. Such a commonsense reform won’t come to pass, however, as returning responsibility to individuals wouldn’t increase the size or power of the government, Congress, regulators, or corporate lawyers like most of the new law seems well-designed to do.

The new Consumer Financial Protection Bureau, for instance, is supposed to give “Americans confidence that there is a system in place that works for them” by “protecting American consumers from unfair, deceptive and abusive financial products and practices.” That sounds wonderful, but why will the new bureau prove any more adept than the SEC, the DMV, or any other government agency? The law will make it the “one office accountable for consumer protections” but if “accountability” doesn’t include pinching the wallets of the bureau’s employees when they err why will they work hard and smart? Again, I’m left wondering why the government thinks that it is a better protector of American’s wealth than Americans themselves are. It’s one thing to catch, judge, and imprison thieves and quite another to tell individuals that you can prevent theft.

Finally, while I’ve advocated increasing financial literacy for years, I have always thought it best promoted by private entities, like the Museum of American Finance, Dollars & Sense Education, and numerous similar organizations. My fear is that the new bureau will inculcate a flawed, monolithic view of consumer finance much the way that the agriculture department used to push its nearly indigestible food pyramid down Americans’ throats.

As I argue in Fubarnomics, the financial crisis was not caused by market failures alone. The government also played major roles, largely unaddressed by the new law. It stretches credulity, therefore, to think that it makes the American economy or the median consumer any safer.

My comments:

Thanks, Robert. You eloquently voiced what lots of AFM readers and I have thought.

*Affiliate Link

One of my goals this year was to try to tackle and make sense of the various economic indicators that we always hear about in the news. So, when I saw Bernard Baumohl’s book, The Secrets of Economic Indicators: Hidden Clues to Future Economic Trends and Investment Opportunities, 2nd Edition* in the bookstore, I picked it up. It’s an excellent reference book for lots of different economic indicators.

In the first chapter of the book, he lists indicators that are most important stock investors, bond investors, the dollar’s value, and the economy in general.

Below is his list of the most important indicators for stock investors. I didn’t include all the information he published in his book but I did at least give you links to each indicator along with the frequency of each release and his sensitivity score. I’ll try to take each one of these indicators and explain them further in subsequent posts. For more information, I encourage you to check out The Secrets of Economic Indicators*, which is an excellent desk reference.

1. Employment Situation Report (News Release)
Market sensitivity: Very High
Frequency: Monthly at 8:30 a.m. (ET) first Friday of every month for the previous month

2. ISM Report—Manufacturing (News Release)
Market sensitivity: Very High
Frequency: Monthly at 10 a.m. (ET) first business day after the reporting month

3. Weekly Claims for Unemployment Insurance (News Release)
Market sensitivity: High
Frequency: Weekly at 8:30 a.m. (ET) every Thursday: covers the week ending the previous Saturday

4. Consumer Prices (News Release)
Market sensitivity:Very High
Frequency: Monthly at 8:30 a.m. (ET) the second or third week following the month being covered

5. Producer Prices (News Release)
Market sensitivity: Very High
Frequency: Monthly at 8:30 a.m. (ET) the second or third week following the month being covered

6. Retail Sales (News Release)
Market sensitivity: High
Frequency: Monthly 8:30 a.m. (ET) about two weeks after the month ends

7. Consumer Confidence and Sentiment Surveys (News Release)
Market sensitivity: Medium to high
Frequency: Monthly 10 a.m. (ET) last Tuesday of the month being surveyed

8. Personal Income and Spending (News Release)
Market sensitivity: High
Frequency: Monthly 8:30 a.m. (ET) four weeks after the end of the reported month

9. Advance Report on Durable Goods (News Release)
Market sensitivity: High
Frequency: Monthly 8:30 a.m. (ET) three to four weeks after the end of the reporting month

10. GDP (News Release)
Market sensitivity: Medium to high
Frequency: Quarterly 8:30 a.m. (ET) advance estimates released the final week of January, April, July, and October. Two rounds of revisions follow, each a month apart.

My post a few days ago about Dave Ramsey’s “Drive Free. Retire Rich.” program received this response from Chuck:

Here is a list of US Stock Mutual Funds from Morningstar Financial with at least a 10 Year track record making annualized returns of 12% or greater. I don’t ever recall DR stating leave your money in the same fund for 40 years and play dead. But maybe it was on a show I didn’t hear.

CGMRX CGM Realty 17.64
SSGRX BlackRock Energy & Resources Inv A 17.17
CGMFX CGM Focus 16.57
PSPFX U.S. Global Investors Global Res 16.57
LEXMX ING Global Natural Resources A 15.76
PRGNX Prudential Jennison Natural Resources B 15.59
RSNRX RS Global Natural Resources A 14.87
GHAAX Van Eck Global Hard Assets A 13.96
VGENX Vanguard Energy 13.51
YAFFX Yacktman Focused 13.10
RSPFX RS Partners A 13.00
ICENX ICON Energy 12.90
FAIRX Fairholme 12.74
IGNAX Ivy Global Natural Resources A 12.49
BURKX Burnham Financial Services A 12.48
FSDPX Fidelity Select Materials 12.48
YACKX Yacktman 12.43
LMVYX Lord Abbett Micro Cap Value I 12.39
HWSIX Hotchkis and Wiley Small Cap Value I 12.22

There’s just one problem with this list…

These are all HISTORIC returns. Ten years ago, would a person have picked these funds, knowing that they would return north of 12%? I think the answer to that is a resounding, “No.”

Also, take a look at that list. Eight of those funds are in natural resources, which would have been a defensive sector ten years ago. Take a look at this Morningstar graph for Van Eck Global Hard Assets:

Notice how the fund didn’t really take off until nearly halfway through 2003. The point? Well, no one would have seen the bull market in commodities coming. Therefore, no one would have had the foresight to invest their car money (referring to the original post) in such a fund.

Now, there are a couple of funds in the list that are general stock market funds. Still, it would have been difficult to pick such funds back in 2000. The Fairholme fund was barely a year old back in 2000.

The bottom line is that although there are funds that returned 12% in the past, it would have been hard to find them 10-years ago. Dave Ramsey’s reckless to use such a hypothetical rate of return with his listeners.