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History Lesson for Stocks: Time to Buy?


     By Fulcrum Inquiry Damages, Appraisal, Accounting & Economics Expert Witnesses

PhoneCall David Nolte at (213) 787-4100


Expert Witness: Fulcrum Inquiry
With the major indexes hitting valuations not seen for more than a decade, one might understandably believe that stocks are a poor place to have one’s money. Regardless of whether you suffered from the recent stock carnage or were smart enough to exit before the decline, the question at this time (or any time) is what will be happening to future prices? Our interactive model calculates historical returns. We then provide the lessons to be learned for today’s market.
With the major indexes hitting valuations not seen for more than a decade, one might understandably believe that stocks are a poor place to have one’s money. With the benefit of hindsight, this has certainly been the case since roughly the end of the third calendar quarter of 2007. But, regardless of whether you suffered from the recent stock carnage or were smart enough to exit before the decline, the question at this time (or any time) is what will be happening to future prices?

The interactive graphic below provides historical perspective. The underlying data is accumulated and reported by Ibbotson Associates (now owned by Morningstar) from 1926.

Here is how the graph works. You select the number of years that you wish analyzed. The interactive model then constructs all available portfolios that are possible using investment data from 1926 through 2008 for the identified possible periods. For example, if one selects a ten-year holding period, the first period covers 1926 through 1935 inclusive, the second period covers 1927 through 1936, continuing until one runs out of possible periods. Using this approach, one portfolio is comprised of 100% corporate bonds, and a second portfolio is 100% large capitalization stocks. A pie chart is shown for each of these two portfolios, with a percentage shown for the number of periods that showed profits, and the remaining percentage for the loss periods.

After you play with this tool for a moment, the following lessons are apparent from the graphs contained in the “Undiversified Portfolio” tab:

1. Over all holding periods, bonds have fewer loss periods than stocks. This is the conventional wisdom. But, the difference between the frequencies of loss periods for stocks vs. bonds is surprising, particularly when the holding period increases.

2. Although a bond portfolio faced fewer loss periods, the bond portfolio generally significantly underperformed stock returns. This can be seen by visually comparing the larger blue lines with the shorter purple lines. This comment describes the conventional wisdom, although the above online graphic demonstrates this powerfully.

3. With a holding period of more than ten years, the only time when stocks incurred a long-term loss occurred because of the stock declines during Great Depression. With longer holding periods, loss periods even during the Great Depression were still infrequent. While commentators describe the current recession as the worse since the Great Depression, practically no one describes the current state of affairs as being as bad as the great depression. Yet, when looked at from a longer-term perspective, the current stock price decline is already worse than what occurred through the Great Depression. From this perspective, the current stock price decline could be fairly described as an overreaction.

4. We are currently in one of those rare times when a long-term bond portfolio beats a long-term stock portfolio. There have been few periods when bonds beat stock returns.

5. At a 15-year holding period for stocks, there is never a period when losses occurred. When applied to 2009’s situation, in order for a 15-year holding period to not generate a loss, stocks will have to rebound sharply over the next three years, thereby erasing all of the losses that occurred over the last year and a half.

One could also create portfolios that include a mix of stocks and bonds. With a mixed bond & stock portfolio, the returns are an average of the bond and stock returns shown in the “Undiversified Portfolio” tab. We have done this math for you, and provided graphs. Click the tab “Mixed Portfolio”. Like the “Undiversified Portfolio”, the graph shows historical results over different periods. However, the mixed portfolio graph shows what occurred with varying percentages of bonds and stocks.


It is always dangerous to tell the future by looking at the past. Yet, the past provides some of the best data that we have. Based on the past, a contrarian investment in stocks is likely the best place to be invested at this moment.

ABOUT THE AUTHOR: David Nolte
Mr. Nolte has 30 years experience in financial and economic consulting. He has served as an expert witness in over 100 trials. He has also regularly served as an arbitrator. Mr. Nolte has achieved the following credentials: CPA, MBA, CMA and ASA.

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While every effort has been made to ensure the accuracy of this publication, it is not intended to provide legal advice as individual situations will differ and should be discussed with an expert and/or lawyer.
For specific technical or legal advice on the information provided and related topics, please contact the author.

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