Talon Eight's Stock Market Perspective: The Good, The Bad and The Ugly

Perspective Overview:

• The Good: The stock market has generated phenomenal long-term results and therefore will remain the cornerstone investment in most portfolios.
  
  
• The Bad: These impressive returns however, have experienced intermittent periods of flat to negative performance.
  
  
• The Ugly: In some instances the stock market has had to endure extreme periods of loss both in magnitude and duration

The Conclusion: All investments whether they are stock, bond or futures orientated have experienced periods of poor performance. In most cases and over the long-term they have been able to fully recover to produce above average returns.

The Good

Our research shows the undisputed fact that the S&P 500 Index produced a total return of 1,500% since 1960. Impressive results given that this test period includes a number of cyclical bear markets. Table 1 below we provide an itemized list of the S&P's performance through the decades. No matter what long-term time frame is evaluated the historic performance has been extremely good.

Point of Fact: It is interesting to note how the annual rate-of-return (AROR) has changed over the decades. The "experts" often quote historical returns for the stock market in the 10 - 15% range. Although this may be true during the secular bull market phase through the 80's and 90's, the more realistic historical return figure is just under 6.00%.

If investors are to participate in the returns of the stock market we believe that they must follow a long-term time horizon. Essentially they should find an investment that is capable of actively trading the stock market and remain with the investment through good times and bad. We believe that investors should avoid jumping from product to product chasing performance. In the end all good things come to those who wait.

Table 1: Historical Performance Results

The chart below graphically illustrates the performance of the S&P 500 over the past 40+ years. The chart includes the 1966 - 1982 secular bear market, which in turn lead to the 1982 - 1999 secular bull market and it concludes with the newly formed cyclical/secular bear market still in effect today.

Chart 1: S&P 500 Index Equity Curve (Log Scale)

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The Bad

Despite the phenomenal long-term performance of the stock market there have been periods of poor performance. Table 2 reviews a wide variety of rolling periods, ranging from 6 months to seven years (84 months). Rolling returns are useful for examining the behavior of returns for holding periods similar to those actually experienced by investors. A quick review of these historic rolling periods will provide investors with the best and worst performance results.

Point of Fact: Notice that the best 60 month (five year) investment period for the S&P 500 generated a total return of almost 220%, while the worst 60 month period produced a total loss of almost 32%. As with any investment you have to take the good with the bad.

Every investor wants to buy low and sell high to maximize returns. Unfortunately in the real world, investors are more likely to invest closer to the worst time than they are the best time. Why? Because it's human nature. Investors typically need to see good performance prior to making their initial investment. The more time it takes to make the decision the more likely the investment will be made at the worst entry point rather than the best entry point.

Table 2: Rolling Period Analysis

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The Ugly

There are a number of ways to measure the risks associated with an investment. One of the risk evaluation tools used by Talon Eight is Peak-to-Valley drawdown. Essentially Table 3 reviews the top ten worst drawdown periods (i.e. cyclical bear markets) experienced by the S&P Index since January 1960.

Point of Fact: During the course of the last eight years, the S&P 500 Index has experienced its worst drawdown period since the '29 Crash. At its worst the S&P Index 500 was down 46.28%. This torturous drawdown lasted for 56 months and more importantly it unleashed the current secular bear market that began back in 2000.

The second worst Peak-to-Valley drawdown occurred in the S&P 500 during the 1969 - 1982 secular bear market in late 1972. In total the S&P 500 Index lost 46.18% of its value at its drawdown valley. Incredibly it took the S&P 500 Index a total of 70 months (i.e. ~6 years) to fully recover.

There are bear markets and then there are BEAR markets. How investors position their portfolios is vastly different when confronted with a cyclical bear versus a secular bear market. We have compiled a great deal of information to make the case that U.S. equity markets have been in a secular bear market and have been so since early 2000. The old long-term buy-and-hold strategy employed by many investors in the 80s and 90s is ill-equipped for the volatile and sideways action of a true secular bear market. Click here for the full story on bear markets.

Table 3: Drawdown Analysis

The underwater equity curve (Chart 3) analyzes a different aspect of performance then the traditional equity chart shown in (Chart 1). The underwater equity curve plots the downside risk exposure experienced by an investor over time. Unlike most equity curves, the underwater equity curve centers exclusively on equity drawdown. Specifically it focuses on the magnitude and duration of each drawdown, or sell off from peak levels.

Chart 3: S&P 500 Index Underwater Equity Curve

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