When I was in high school my social life was limited due to bad skin and a lack of popularity. I didn’t get to many parties and didn’t go on many dates. Most nights were spent at home with my family watching television. Cable television was in its infancy. We didn’t have it. But we did have good reception of four stations. If my brother put aluminum foil on the rabbit ears and stood on the side of the Zenith keeping a finger on the antenna, we could watch some of the programs on Channel 53.
Tuesday night was the night “Happy Days” was broadcast. My family, and maybe yours, put our lives on hold for thirty minutes while we checked in with Richie, Mr. and Mrs. Cunningham, Fonzie, Ralph Malph, Paula Petralunga, and Mr. Potsie Weber. It seemed that high school life in Milwaukee in the 1950’s was much more girl-friendly than my high school life in 1970’s Pittsburgh.
When the program was discussed on talk shows hosted by Mike Douglas and Merv Griffin or reviewed in print, the discussion was always about how the 50’s were a more tranquil time for Americans. Supposedly there was less stress and less to worry about. As a fan of stock market history—and therefore history in general—I wonder exactly in which part of the decade those “Happy Days” occurred.
I don’t think it was at the beginning of the decade. The Korean War started in 1950 and lasted until 1953. Polio was still a risk to the young until Jonas Salk’s vaccine was announced to the world in 1955. Joe McCarthy was on his witch hunt looking for Communists inside the entertainment industry and the government. The post-WWII housing shortage was still an issue. A ten-month long recession followed the end of the Korean War. Russia was attempting to add to its collection of Soviet Republics and developed the hydrogen bomb in the early part of the decade. This resulted in students at various schools spending the rest of the decade “ducking and covering” under their desks. I don’t think they were too happy about that.
The middle of the decade saw the United States getting involved in Vietnam. The CIA engineered coups in Guatemala and Iran (and who really knows what else) and the Ku Klux Klan was making its agenda known in the South. I wonder if the average black man in Mississippi took time off from worrying about the Klan to realize how ‘Happy’ his days were?
The end of the decade? Don’t think so. A deeper recession than the one that happened at the beginning of the decade hit between ’57 and ‘58. The Cold War was getting Colder. Involvement in Vietnam was increasing each year. All the pieces were being put into place, or were already in place, to serve up the tumultuous 60’s. Happy Days? Sorry, Potsie, but I don’t see it.
The world has always been a volatile, violent, inconsistent, fickle, unstable place. Happy Days was not indicative of any time in history. It was just a silly TV show that jumped the shark when Fonzie jumped the shark. The concept of the “Good Old Days” only comes about because, as humans, we’re naturally optimistic. Most of us look toward the future with great hope and anticipation that our current situation will be better in the future. Maybe we have a “reverse optimism” gene that enables us to look back in time and have our memories clouded so we think times were better than they really were.
The Chart
When the stock market was hit by the double whammy bad news of the debt problems in Greece and the Gulf oil spill I decided to take a look at how major adverse world events that happened in my lifetime affected the performance of the stock market. The attached chart lists ten world events between 1962 and 2001. The event is listed along with the first trading day that would have been impacted by the event. For events that unfolded over days or weeks and for which exact dates weren’t available (i.e. the OPEC Oil Embargo, Asian Currency Crisis) I chose the highest value of the S&P 500 Index before the event and subtracted from it the lowest value during the remainder of the year. I gave myself the biggest market decline for each occurrence. The performance of the S&P 500 Index during the event, six months later, one year later and five years later is provided. The data is the Price change of the Index. The impact of reinvested dividends is not included in these changes. This value is higher than the Compounded Annual Growth Rate (CAGR) which will be discussed below.
Event
Dates Under Study | Performance
During Event | Six Months Later | One Year Later | Five Years Later |
Cuban Missile Crisis
10/16/62 – 10/26/67 | (4.76%) | 27.7% | 35.69% | 74.07% |
Kennedy Assassination
11/22/63 – 11/22/68 | (6.0%) | 15.91% | 23.54% | 52.7% |
Summer of Strife
04/03/68 – 06/06/73 | 7.7% | 10.94% | 9.25% | 11.5% |
OPEC Oil Embargo
10/17/73 – 12/05/78 | (19.32%) | (17.14%) | (31.86%) | (11.39%) |
Nixon Resignation
08/08/74 – 08/29/79 | (14.19%) | 16.57% | 24.13% | 55.76% |
Iran Hostage Taking
11/02/79 – 11/05/84 | (.006%) | 4.3% | 28.98% | 65.56% |
Black Monday
10/16/87 – 10/19/92 | (20.46%) | 14.6% | 23.18% | 84.56% |
First Gulf War
08/02/90 – 08/03/95 | (6.62%) | 2.3% | 9.55% | 58.97% |
Asian Currency Crisis
08/06/97 – 08/29/02 | (6.33%) | 16.47% | 6.42% | 2.03% |
September 11th
09/10/01 – 09/21/06 | (11.6%) | 5.5% | (13.6%) | 36.4% |
Source: Yahoo Finance GSPC Historical Prices
In each instance, after each adverse event, the market was positive six months later except after the OPEC oil embargo. The market was positive one year later eight out of ten times. Five years after the negative events the market was positive nine out of ten times. The negative numbers associated with the OPEC embargo jump off the page and demand a closer look.
The embargo started in October of 1973 when OPEC announced a 70% increase in the price of a barrel of oil. The embargo was fueled by two things: The Arab world’s retaliation for the U.S. military assistance to Israel and the impact of U.S. inflation on oil pricing. (The new price after the 70% increase? $5.11 per barrel.)
Due to the increased spending in the mid-60’s required to fund the Vietnam War, Medicare, and the various social programs, the inflationary impact was well underway by 1973. The U.S. had been paying a low fixed amount per barrel of oil and exporting our products with inflation increased pricing to the oil producing countries. They were paying higher amounts for our products and we were paying the same amount for the one product they had that we wanted: oil. OPEC was going to do something and they did. They decreased production which resulted in the embargo. But the stock market’s decline was not a result of the embargo. The embargo was a symptom of the inflation virus inside the economy.
The ten-year period from 1959 to 1968 had an annual increase in the Consumer Price Index (CPI) of 2.08%. The inflationary period in the U.S. economy lasted from 1969 to 1981. During this period the CPI averaged 7.84%. The S&P 500 Index averaged 7.25% (the 50-year AAR (1960 – 2009) is 11.00% with reinvestment of dividends). It wasn’t until Federal Reserve chairman Paul Volcker broke the back of inflation by increasing the Federal Funds rate from late 1979 through June 1981 that the inverse situation righted itself. As evidence, the CPI was 13.29%, 12.52% and 8.92% for 1979 through 1981. After the inflation monster was tamed the CPI dropped to 3.83% in 1982. The S&P Index then went on a ten-year tear where it averaged 18.09% per year. Since inflation became a non-issue there has been only one year (1990) when the CPI was over 6%. Over the last ten years, the CPI Index has averaged 2.53% per year.
When the CPI was almost double its historic average, the S&P 500 Index averaged 65% of its average. Above all else, high inflation eroded stock market value more than any of the events in the study.
The value of the market one year after September 11, 2001 and five years after the Asian Currency Crisis can best be explained by the Year of the Accounting Scandal (2002). Enron’s cooked books came to light at the end of 2001 and were followed by Tyco, Worldcom, Adelphia, Global Crossing, et.al. into 2002. In reality the market decline that happened right after the planes went into the World Trade Center was recaptured before November 2001 reached its end. The market was up strongly six months after the Asian Crisis but retreated one year later due to the spin-off Russian Currency Crisis. Evidence that the world is so volatile that before one crisis can be assimilated and absorbed, another one happens.
AAR vs. CAGR
The reader may find it of interest that in the 50 years under study, with an AAR of 11.00% for the S&P 500 Index, that the percentage split of positive to negative trading days was a surprisingly close 53 to 47, that there were negative years 24% of the time (including the double negative years of 1973 and 1974 and the triple negative years of 2000 through 2002). The Average Return of the Index in the year after a negative year was 11.74%.
Average Annual Return differs from Compounded Average Growth Rate in that the CAGR accounts for the actual value of your money after a period of returns. If you were to achieve a return of 100% in Year 1 and a negative 50% in Year 2, your average return would be 25% (100 minus 50 divided by 2). But your CAGR would be zero. You would be right back where you started. Another example: the Index had these returns for 1976 through 1980: 24.20%, (7.78%), 6.41%, 18.69%, 32.76%. The AAR was 14.86% but the CAGR was 13.94%. CAGR tends to be lower than the AAR.
If an investor were fortunate enough to have $100,000 on January 1, 1960 and invested it into the Index, what would it be worth today? They would have had to stay invested through the events on the chart plus the Vietnam War, the Kent State Shootings, Gerald Ford wearing his “WIN” button (for Whip Inflation Now), the Inflation-Busting Recession (the button didn’t work), “Joanie Loves Chachi”, the savings & loan scandal, the onset of AIDS into the world, the first World Trade Center attack, the Oklahoma City bombing, the mutual fund trading scandal, currency crises in England, Russia, Argentina and Mexico, the turn of the century Y2K headache, the Summer of the Accounting Scandal, the ongoing wars in Iraq and Afghanistan and countless other events not listed here. What would that happened to that Fortunate Son’s $100,000? At the end of 2009 his value would have been $9,144,256. This equates to a CAGR of 9.45% and an AAR is 11.00%. (Going forward, when comparing returns of various investments, make sure you’re comparing apples to apples. CAGR is the most relevant apple).
Index vs. Active Management
We’ve discussed the S&P 500 Index to this point. Now here’s a curveball. You shouldn’t invest in the Index or Index Funds. The main reason: by buying the Index you’re purchasing the stocks of companies you want with the stocks of companies you don’t want. You would have owned all those companies caught up in the 2002 Accounting Scandal if you owned an Index fund. Reason Number Two: dividends. I’m a dividend-oriented investment advisor. All the stock funds or equities I use in my practice pay quarterly or annual dividends. While an Index fund would pay you a dividend quarterly that dividend is kept to a minimum because, at any given time, about 150 to 170 members of the 500 companies in the Index aren’t paying dividends. My proof: the current divided yield of the S&P 500 is 1.7%. Actively-managed equity-income funds have yields hovering around or above 4%.
Here’s a double lesson in the power of actively-managed funds and compounded growth. I am a seller of select funds inside the American Funds family. Three of their funds, American Mutual Fund, Investment Company of America and Washington Mutual Investors Fund, have inception dates pre-1960. (As a matter of disclosure I do not use any of the three funds in my portfolios). Over the same time period that the S&P 500 Index had a CAGR of 9.45%, the CAGRs of American Mutual, ICA and Washington Mutual were 12.02%, 12.27% and 12.17%, respectively. That slight difference in yield, over 50 years, resulted in year-end 2009 values of $15,242,650 for American Mutual, $17,554,221 for ICA and $16,626,861 for Washington Mutual (remember: the 50-year growth of the Index resulted in a value of $9,144,256). The higher CAGR and dollar values for the three American Funds are after a one-time sales commission of 3.5% and an annual expense ratio deducted from the plan assets (current annual expense ratio for American Mutual Fund is 67 basis points, 66 basis points for ICA and 70 basis points for WM. There can be commission and there always are fees for an Index fund but there are no charges for the Index itself).
These examples show how vital minor differences in rates of return are when compounded over periods of time. Yet many investors are giving away part of that yield by overpaying for the management of their assets (If you want a dissertation on the evils of high asset management fees, simply ask me the time of day. I’ll tell you the time and then talk to you for the next thirty minutes about management fees. This has been one of my favorite subjects since I was able to take a look around the industry and see what really mattered. Unfortunately, the subject has been largely ignored by the investing public).
Fortunate Son
Let’s take a look at our Fortunate Son’s $100,000 in another way. Say the $100,000 was invested for growth for 30 years and then used for income distribution purposes. Beginning in 1990, $100,000 was distributed each year. A 3% increase in the distribution occurred annually.
The following chart shows the value of the three American Funds and the Index at 12/31/89, the value of the income received and the ending value.
| Fund | 12/31/89 Value | Income Received
1990 – 2009 | Value 12/31/09 |
| AMF | $3,013,935 | $2,687,037 | $9,915,040 |
| ICA | 3,216,548 | 2,687,037 | 12,449,595 |
| WM | 3,134,120 | 2,687,037 | 11,392,281 |
| S&P Index | 1,890,935 | 2,687,037 | 4,167,626 |
The above is strong evidence why you need low-fee, well-researched, dividend-yielding active asset management instead of passive Index fund investing. If one of the American Funds had beaten the Index, that’s luck. When all three beat it, that’s skill (or an ass-kicking).
Volatility
Just as the world is a volatile place, so is the stock market. Volatility will never jump the shark. It will always be present. As evidence: the 50-year AAR of the S&P 500 Index (with dividends reinvested) is 11.00. Yet there have only been four years when the Index had a return during a calendar year within two points plus or minus that average. There’s nothing average about that average return. One hundred point trading days…up or down…will become more common. Two percent trading days…up or down…will also become part of our investing lives.
2008
No discussion of the history of the investment markets is complete without a discussion of the 2008 market decline. At the beginning of that year I wrote an article talking about the coming recession and the history of the business cycle. Because we didn’t have a true negative year since 2002 we were due for a negative year and I braced for one. My problem is I braced for a maximum negative year of 20%. We had 20% declines in 1974 and 2002 and I had just gotten my securities license when the market lost 22% in one day on October 19, 1987. And we did get that 20% decline. But we also got another 18.4% decline the week of October 6th to October 10th. I have a strong recollection of checking the Asian markets the night of Sunday October 5th. Most of them were down 2%. The U.S. futures markets were negative into triple figures. Each evening during that week I woke up (I should say I got out of bed because I wasn’t really sleeping) and checked the Asian markets. Nothing but red. Major losses. The red lighting on the computer screen seemed to have flames shooting up in the background. During one day in the middle of the week the futures were negative 200 points plus. Right before the market opening at 9:29 a.m., one of the commentators on CNBC announced the market was about to open. And he followed his statement with “…and I wish to God it didn’t have to.”
The alternative energy-related investments and cash positions my clients were in weren’t enough to save them from the 36.99% decline of 2008. But late in that year I knew that part of the decline was a bubble bursting and part was the overselling that accompanies such bursts. During the spring of 2009 the sellers of stocks in 2008 became buyers again. My research showed that in the previous three calendar years when the market suffered a 20% decline, the following year’s return averaged 32% (2009 returned a positive 26.47% for the S&P Index). In the 20 years after the 43.3% decline in 1931, the Index gained an average of 11.7% per year. Following the fourth quarter of 1987 (which contained Black Monday), the Index averaged 11.8% over the next 20 years. One of the most unique statistical facts I came upon was this: in the calendar year after the five previous seasons that the Pittsburgh Steelers won the Super Bowl (1975, 1976, 1979, 1980 and 2006), the Index averaged 25.6%. When James Harrison intercepted Kurt Warner’s pass at the goal line right before halftime and returned it up the sideline for a touchdown, he didn’t realize he was running for a major positive year in the stock market just as much as he was running for fans of the Steelers. It was the most important play in the Super Bowl XLIII, the game to decide the champion of the 2008 season. The knowledge of these historical market facts, plus yoga classes, helped me deal with my newfound stress. I don’t know where the market will be on October 10, 2013 but I do know it was up 18.9% one year after October 10, 2008.
Summary
In 2006, 100 years after its publication, I read Upton Sinclair’s seminal novel “The Jungle.” For those of you who haven’t yet had the experience of reading it, the story tells the saga of a group of Lithuanian immigrants who come to Chicago in hopes of a better life. The story begins at a typical Eastern Europe wedding reception used to introduce us to the main characters. The protagonist and groom, Jurgis Rudkus, soon finds employment in a meatpacking plant. And then there is not one happy moment for the rest of the book. Horrendous working conditions topped by even worse living conditions. Injury, death, scams, eviction, poverty, sexual harassment, broken families, corruption, exploitation, humiliation etc. It was a horrible story. But it was an insightful and important book. The noise this book made around the world created, with President Theodore Roosevelt’s blessing, the Meat Inspection Act and the Pure Food and Drug Act of 1906. The latter established the Bureau of Chemistry which became the Food and Drug Administration in 1930. The book caused government to get more involved in dictating how businesses treat their employees and their customers. Like it or not, “The Jungle” is what turned our economy from capitalism to regulated capitalism.
When I was on the construction crew, it was because of this book that I only had to work 40 hours a week and that I had a safe workplace. If I had been injured it was because of this book that I would have received medical treatment instead of being terminated. It was because of that book that I made good hourly wages.
And it was probably because of that book that I have a reasonable expectation that the food I buy is not going to make me sick, that the car I drive is going to be mechanically sound and that the buildings I go in and out of each day are built properly. And if a provider of goods and services is found to be engaging in “Jungle” type behavior, they’re going to be called on it and made to amend their ways or go out of business. Since 1906 to now, every industry operates more honestly and openly (OK, except the nutritional supplement industry) than it did 100 years ago.
Because the standard of living has improved so much since “The Jungle” was published, I know that when the outside temperature is cold I can stay warm. When the temperature is high I can find a way to cool off. In one hundred years, all of us have had our working and living conditions increased exponentially above and beyond what the characters in “The Jungle” had to put up with. Even when the stock market is negative, day to day life is not so difficult to get through. We have life much easier than the immigrant family in “The Jungle.” I’m going to use my “reverse optimism” gene and say that each day since “The Jungle” was published has been Happy Days for most of us.
And I’m also going to say that I should have spent more time during high school reading important books than watching silly television shows.
Sources
Wikipedia, Yahoo Finance, American Funds Hypothetical Illustrations, BTN Research, www.standard&poors.com, www.moneychimp.com, and the author’s previously published work.
Opinions expressed are those of the writer and are subject to change based on market and other conditions.