Saturday, October 11, 2008

Negative Decades of Returns: A Long-Term Look at the Dow

With the severe market decline this past week, the 10-year percentage change for the Dow Jones Industrial Average ($DJI) has fallen to single digits, and it appears likely that we could head into negative territory in the weeks to come.

A long-term historical look at the Dow since 1910 finds that ten-year periods of negative returns are not so unusual. They occurred in 1915, during the Great Depression years, and then during the severe recessionary period in 1974. Both the 1930s episode and that beginning in 1974 lasted a number of years: once 10-year performance went negative, it stayed that way for quite a while.

These periods of 10-year underperformance are not common--they account for only 4469 of the more than 26,000 days in my sample. Interestingly, only the occasions falling during 1937 showed losses over the following ten years: 4314 occasions showed subsequent 10-year rises, 155 showed losses. The median size of the 10-year gain following 10-year weakness was actually a bit smaller (61%) than the median size of 10-year rises for the remainder of the occasions (85%). In short, staying out of stocks following 10-year periods of underperformance did not benefit investors, but on average they did not see unusual outperformance either.

What this little exercise suggests is that periods of long-term market underperformance can persist over time--they do not necessarily lead to durable rebounds simply because of oversold conditions--but that fleeing markets during these periods of long-term underperformance has not been a winning strategy over the long run. Even after momentum lows were registered in 1932 and 1974, markets engaged in long periods of basing before new secular bull markets kicked in. So far, it is not at all clear that we've seen those momentum lows. I'll need to see those--and some evidence of meaningful basing--before aggressively pursuing the next secular bull market of triple digit 10 year returns.


SSK said...

Hello Brett, Very insightful chart, thanks. I am glad I am a daytrader and not a buy and hold investor! Steve (SSK)

Andrew Abraham said...

Nice post Brett.. we have been speaking of exactly this on the chats of as well as the example of Japan... however some members brought up the point of Sweedan and how they resolved their economic issues in the early 90s...Do you think the bailouts will work and change the situation... Please let us know..thanks

abel said...

What insights might that same chart provide if overlayed with inflationary/deflationary periods?

I think a case can be made that as periods transition from inflationary to deflationary, that even as an inflationary period is abating, perhaps as we are currently experiencing, that the reality as it pertains to most individuals, (due to loss of wealth / latent/persistent loss of purchasing power), that in the waning portion of an inflationary period, actual inflation may rise, making the transition and process endure longer than 'reported inflationary numbers' may on the surface indicate.

For instance, in housing, many markets are deflating, and on the surface, housing may appear more affordable. Yet, in fact, housing may be less affordable for most, even at lower values, due to rising interest rates, less available credit, and the perception, real or otherwise, that even in a 'deflating market', housing may represent a risk, (ie, a possibly overpriced asset), due to the requirements of other financial obligations. This may in part still make the effects of housing 'inflationary', even in a deflating market.

This dyanamic may apply across other market sectors, autos, for example, and when aggregated, may compound across the economy, prolonging the inflatioanry effects, even as markets are deflating.

Perhaps that may be what is reflected in the prolonged periods of basing you reference in the chart above.

Cavemanus said...

One could look at the chart's apparent cycle and argue that we are just entering a period of low returns.

What impact would a decade or two of low returns have as baby boomers begin retiring?

Bryan said...

I've come back to several times to look at this fascinating chart. Thanks.

myinvestorsplace said...

superb chart! I have downloaded one and on my cabin notice board! Great research!

Andrew Abraham
MyInvestorsPlace - trading, value, investing, forex, stock, market, technical, analysis, systems

Leonardo said...

It would be interesting to know what the mean return is... Nevertheless, a simple visual analysis immediately highlights how uncaracteristically high returns remained during the '90s and early 2000 (versus the past) that it wouldn't be so improbable to assume that they will remain (abnormally ?) low for a while to come.... The banking crisis of the 1873 is a far better road map than 1929 in my mind to gauge where we might be heading.