Dick Davis – Part 2

Thanks to Jon Bakke for forwarding this review of Kevin Phillips’ new book, Wealth and Democracy: How Great Fortunes and Government Created America’s Aristocracy. (To read the whole book, click here.)

And now, back to Dick Davis (as introduced yesterday), with the first handful of his 35 ‘items.’

Item 1: What’s A Reasonable Return?

What kind of return should we expect in today’s stock market? The 5-year period 1995 thru 1999 spoiled us. Both the Dow and Nasdaq registered their biggest successive gains on record, the Dow up an average 25% during that period, Nasdaq a hard to believe average of 42%. Expectations the past 2 years, however, have dropped sharply. Robert Farrell, the highly regarded 40-year veteran commentator for Merrill Lynch (and my favorite), says, ‘Virtually everything the market represented in the past decade is unlikely to continue in the years ahead.’ Farrell looks for less active markets, lower volatility and profits that will be modest and harder to achieve. He believes investors will need more patience and that goals are likely to change from the maximizing of stock returns to the preservation of capital. In the past, professional advisors would shoot for an average annual gain of some 15% – usually a lot more in some years and a lot less in others. As for the over-all market itself, for the 70 years prior to 1995, the average annualized total return (dividends plus appreciation) was 10 1/2%. Today even that number may be high. Famed investor Warren Buffet has said he expects returns in the stock market to average 7 to 8% over the next 10 years.

Item 2: Groups Will Return To Favor

An individual stock that was once popular, may or may not return to favor. But an industry group that is unloved will, at some point, recover. Not sometimes, but always. It may take a long time but eventually it will once again have its day in the sun. That doesn’t mean that every stock in the group will participate. Less seasoned or marginal stocks may not join the group’s revival – a compelling reason to invest in industry leaders.

Item 3: It’s Never That Urgent

When reading or listening to the hype that often accompanies the recommendation of stocks, keep in mind that no one stock has to be bought. There’s always another stock and there’s always another day.

Item 4: The Durability Of Major Trends

Well entrenched trends, whether they apply to the overall market, stocks, interest rates, inflation or the economy, are exceedingly difficult to reverse. They usually not only last longer but they go further than we expect. The stock market went from Dow 769 in 1982 to Dow 11,722 in 2000, an 18-year bull market. Inflation dropped from 13 1/2% in 1980 to 1 1/2% in 1998 and its not much higher than that now. Again, that’s an 18-year downtrend in inflation. Interest rates declined from 14% in 1981 to 3 3/4% in 1998, an almost 17-year bull market in bonds. The economic expansion started in 1991 and ended 10-years later last March. Of course, these were not straight line trends. There were corrections, some quite long, along the way. But the overall primary trend prevailed. It was powerful and amazingly durable. It traveled a long way for a long time. And the longer the existing trend is in force, the more likely it is to remain in force. The 60 year old male with a life expectancy of 80, once 80 is expected to live another 8 years and then another 5 after that. If you learn to trust the durability of the primary trend and not let false countermoves shake you out, you will increase your odds for success. Awareness of this phenomenon also makes it easier to put into proper perspective the daily onslaught of news and opinion. One caveat: Typically, bear markets do not last as long as bull markets.

Item 5: Face It, It’s History

If a stock has collapsed from 50 to 5, people often ask, ‘Should I hold or take my loss?’ The answer is, ‘You’ve already taken your loss. It’s academic whether you sell or not. The loss is history. Write it off mentally, if not actually, and go on from there. The odds favor that whatever money is left can be better used in a better situated stock. If you decide to hold and the stock beats the odds and comes back, that’s gravy, but don’t count on it.’

Item 6: The Role Of Market History

Sometimes, stock market history reveals recurring patterns of behavior that can help put the odds in your favor. For example, Presidents tend to focus on unpopular initiatives in the early years of their administration, saving the best stuff for the period before the next election. That may or may not be the rationale for this finding from Robert Farrell of Merrill Lynch: He says, ‘There has been a very consistent 4 year cycle over several decades in which stocks have made their most important lows in the middle of a Presidential cycle rather than at the beginning or end. Important lows were made in 1966, 1970, 1974, 1978, 1982, 1986 (1987), 1990, 1994 and 1998.’ This would suggest that a low may occur this year, the 2nd year of the current 4 year term. Then again, it may not, but it’s certainly a pattern worth noting. Incidentally, offsetting this pattern of important lows being made in the 2nd year of presidential terms is this intriguing fact: if the market ends lower this year, it will have to do something it hasn’t done in 70 years – namely go down three years in a row. The only time that’s been done is back in 1929 thru 1932.