"Long term" outlook and timeframes

This is a good time to refresh my long term outlook, and give a little philosophy as well.

Previously, I've given my "long-term" view that equities will go down, at least on an inflation adjusted basis. By "long-term", I mean 10-15 years or so. If so, why do I talk stocks all the time? Because its all about the time frame. If you are looking to buy individual stocks and sell them after a few days, weeks, months, or even a couple years, you may do very well. If on the other hand you have a 30-50 year (or greater) time frame, where you can leave the money alone till the end of that time, the historical evidence is pretty good that buying and forgetting a broad basket of equities will do okay. If, however, you expect to dollar cost average into an index fund and get 10% returns and retire rich in 10 years, I think you will be sorely disappointed.

Why do I believe this? History. The historical evidence, in this country, shows alternating periods, of about 10-20 years or so, of rising equity prices alternating with equity prices going nowhere or down. The periods of rising equities start with low valuations and run till valuations are high, and then the bear kicks in and equities fall till the valuations are low (or stand still till earnings rise enough to make the valuations low). Roughly, bull market in the 1920s, bear until mid-1940's, bull 1946-1966, bear 1966 to 1982, bull 1982-2000, bear 2000-?. Michael Alexander in his excellent book Stock Cycles, goes into this in some detail and fleshes out some reasons why this may be so.

The other reason I believe this is that there is just too much of "the crowd" in index funds. When John Bogle pioneered the idea of dollar cost averaging into "the market" via low expense index funds, it was a great idea because it was new, simple, and most of all, it was historically a great time to do this (1970's) because stocks were at low valuations and thus we had a great bull market ahead. Now, with equities still at historically high valuations, I think just blindly DCA'ing into indexes is a sure way to throw money away unless your time frame is 30-50 years, i.e. long enough that you can ride out this present cycle. Let me add that when I say your time frame is X number of years, I don't mean just are you going to live that long, I mean you don't need to touch the money, principal, interest, any of it, for X number of years--because that is really the key--to be able to ride out the lows in valuation until they start to rise again.

Thus, to try to put it together, if you have money that you will "need" in 5, 10, or perhaps even 15-20 years, I think you have to be more of a trader. You have to be willing to 1) have a thesis for why a stock will go up, 2) decide at what point your thesis will be proven wrong, and 3) be willing to cut your losses when your thesis is wrong. This last point, cutting your losses, I think leads into another point about technical v. fundamental analysis, which simplistically, is the difference between, when prices go down, do you sell to cut your losses, or do you buy because its a better bargain. I think actually I should expand upon that in a future post, but for now I'll say again, you need to decide in advance on what will make you decide that your thesis is wrong. Obviously, if you are trading on the technicals, it will be purely a matter of price that changes your thesis; if you trade on the fundamentals, then its a matter of has the valuation story changed. However, if your thesis is fundamental, then I think money management is even more important; you have to accept that you may be wrong on your thesis, the bargain may be a bargain because it is going to go bankrupt, and if you lose all of this investment, it doesn't break you.

In future posts I intend to 1)expand on the technical v. fundamental idea, 2) talk about what kinds of equities I believe are exceptions(hubris alert!!!) and may be able to outperform over the next few years, and 3) talk about other asset classes--commodities, etc.