Stocks for the Long Run, Part 2 - The Stock Market and the Economy are Different Things

This is Part 2 on my series discussing “Stocks for the Long Run” by Jeremy Siegel. The book uses historical data going back to 1802 to make a case for owning stocks, despite their risks.

Part 2 – The stock market and the economy are often out of sync

Jeremy Siegel introduces this topic by describing a well-respected economist predicting GDP growth in the next year, no economic recession for at least 3 years, and increasing corporate profits. The time of these predictions was the summer of 1987, just weeks before the market began to crash, when many stocks can be bought for half the price at the time of the predictions. He goes on to say “The biggest irony of all is that the economist is dead right in each and every one of his bullish economic predictions.”

The stock market crash was largely directed by investor emotion and not by underlying financials. Over long periods of time, economic activity plays a vital role in the direction of the stock market. However, stocks can be largely disconnected from the economy, sometimes for years on end. Because of this, predicting the top or bottom of the market is so often a losing proposition.

If you take a look at the data, it is pretty darn convincing. From 1948-2012, the average bottom in the stock market took place 4.6 months prior to the bottom of the business cycle. If you thought you would get out of the markets and wait until the bottom occurred, you might say, “that’s not a long time, I can wait a few months.” However, the average stock market return in those 4.6 months is 23.81% on average. And on top of that, there is typically not confirmation that the recession has ended until many months after the bottom of the business cycle, so you would very likely find yourself waiting even longer to get confirmation that things have in fact turned around.

Disclaimer: Mention of any author, their publications and materials does not constitute endorsement or recommendation.  We do not assume responsibility for the validity of cited references or the consequences of their use.  All references to bonds refers to US long-term government bonds and all references to stocks refers to dividends plus capital gains on a broad based capitalization-weighted index of U.S stocks. Alex Voorhees and Reston Wealth Management do not provide legal, accounting or tax advice. This information is not intended to be a substitute for specific individualized investment, tax or legal advice. We suggest that you discuss your specific situation with a qualified investment, tax or legal advisor. The opinions voiced in this article are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) or strategies may be appropriate for you, consult your financial advisor prior to investing. No strategy assures success or protects against loss. You should consider the investment objectives, risks, charges and expenses of any investment carefully before investing. You cannot invest directly in an index.

Citations

Siegel, Jeremy J. Stocks for the Long Run: the Definitive Guide to Financial Market Returns & Long-Term Investment Strategies. McGraw-Hill Education, 2014.