TCS Daily


It's A Great Day For Investing

By James K. Glassman - March 20, 2001 12:00 AM

The late "Badger" Bob Johnson, beloved coach of hockey's Pittsburgh Penguins, used to greet his players by saying, "It's a great day for hockey." It was a gag, of course, since hockey's played indoors and the weather is irrelevant, but it summed up Johnson's infectious enthusiasm. Every day is a great day if you're playing a game you love. Ten years ago, Johnson's energy and enthusiasm transformed the Pens from NHL doormats into Stanley Cup Champions.

There's a lesson here for investors who want to be champions at building wealth. Every day is a great day for investing, if you plan to be a long-term shareholder. Your financial future is no game, of course, and we're talking about money instead of love. But it's important to remember that every day you put money into the market is a good day for your finances.

I know it's not easy to think that way in the current environment. Now that the NASDAQ has tumbled almost 65 percent from its high, with technology stocks taking a daily drubbing in the markets, this may seem like a very risky time to invest in tech companies. In fact, we know from hindsight that the really risky time to invest was last March, when the NASDAQ sailed past 5000 on a wave of new economy euphoria. Dropping more than 60 percent in a year - now that's risky - but it's not a disaster unless it makes you turn your back on equity investing. In fact, now is a wonderful time to put new money into stocks - or to keep your money in stocks -- if you can screen out the negative noise.

Worried that the markets will tumble even further to new lows in 2001? There are two very good reasons not to worry about that possibility. The first is that history shows that investing in stocks is the smartest, safest investment for the long run, even if your timing is horrendous. The second is that the "irrational exuberance" of investors in the late 1990s has largely been wrung out of the market.

First, let's talk about timing - should you invest now or wait awhile on the assumption that the markets will fall even further? Don't assume that further losses lay ahead. During the bull market I constantly warned people not to try to call the top of the market. It's an almost impossible task. Ditto for the market's bottom. And in any case, your timing is a lot less important than you may think.

Several years ago, analysts at Capital Research and Management Co. tried this exercise: They invented a fellow called "Louie the Loser," who every year put $ 5,000 into Investment Co. of America, an actual mutual fund managed by Capital Research that has consistently produced returns that closely track the market as a whole.

As his name implies, Louie the Loser had terrible timing. Each year, he chose the worst possible day to invest his $5,000 in ICA: the day the Dow Jones industrial average hit its annual peak.

Still, after 20 years Louie's total investment of $100,000 had grown to $441,000 -- an average annual return of 13 percent. By contrast, a perfect market timer, who invested $5,000 annually on the day the market hit its low each year, scored a return of 15 percent. Not much difference.

The reason is that time, not timing, is what matters. So Bob Johnson would have made a great financial planner. In our fictional example, every day was a great day to invest for the future. The best strategy is to buy stocks early and often -- and to resist the urge to bail out when the going gets tough.

That's the message of one of my favorite books on investing, "Stocks for the Long Run," by Jeremy Siegel of the Wharton School of Business. After extensive research covering two centuries of financial history, Siegel concluded that "the constancy of the long-term, after-inflation returns on stocks was truly astounding."

Unless your horizon is very short, stocks not only return far more than the alternatives, they "are actually safer than either government bonds or Treasury bills."

If the Louie the Loser story doesn't give you solace, then consider Siegel's analysis of the "Nifty Fifty," the hot growth stocks of the early 1970s. Investors bid these institutional darlings -- such as Xerox Corp., Coca-Cola Co. and Merck & Co. -- up to astonishing levels. In 1972, they sported average price-to-earnings (PE) ratios of 37, or about double the PE of the market as a whole. One-fifth of the Nifty Fifty stocks had PEs over 50; Polaroid Corp. had a PE of 90, McDonald's Corp. a PE of 60.

Talk about top of the market! The conventional wisdom in subsequent years was that the Nifty Fifty stocks were vastly overvalued, and that anyone who bought them as "one-decision" investments (as they were touted to be) was simply a fool.

But, as usual, the conventional wisdom was wrong. In his study, Siegel assumed an investor bought a portfolio of the 50 stocks in 1972, at the peak of the frenzy, and held them through 1993. Total return for the period averaged 12 percent annually, or slightly better than the market as a whole and well ahead of bonds (9.2 percent) and Treasury bills (7.4 percent).

On an after-tax basis, the differences were even more spectacular. The Nifty Fifty returned 9 percent; bonds, 5.4 percent; T-bills, 4.3 percent. Only three of the 50 stocks lost money.

This is a timely lesson for investors who today are concerned that stocks may fall even further before recovering. Are stocks still overvalued? Possibly. But in the long run, their earnings should overcome that drawback, even if the market takes a dive in the meantime.

There's also a case to be made that tech stocks are now fairly valued. It's true that valuation can be a slippery concept. In our book Dow 36,000, Kevin Hassett and I argue that investors have historically undervalued stocks because they haven't appreciated that stocks are no more risky than bonds over the long haul. In any case, let's look at the NASDAQ market and the returns it has generated for investors compared with the historical norm. It turns out that the market is right about where history says it should be.

What do I mean by that? Well, let's look at the past five years, when the NASDAQ was the epicenter of new economy excitement and then ground zero in the dot-com meltdown. When all is said and done, the NASDAQ has delivered returns that are slightly above average. The index is about 75 percent above its level of five years ago. To put it another way, the NASDAQ has delivered an average annual return of almost 12 percent since this time in 1996. That's slightly better than the long-run average of stocks since 1926 -- what you might call the modern history of the market - but pretty close to average. Not wildly exuberant. Not soaring to bubble heights. Just average.

The pain of 2000 and the tech wreck are behind us. If tech stocks were once selling at bubble prices, history says that NASDAQ is now behaving just like an average bunch of stocks for the long haul, no more or less. If you believe, as I do, in the power of digital technology to improve efficiency and enhance our lives, this looks like a wonderful opportunity to buy shares in great American tech companies. It's a great day for investing.

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