My mentor in this business often tells me that to be successful, knowing some financial history is essential. Many people would argue that it’s always good to know more about the world we live in but, in a more practical sense, being well informed on history is very helpful to the investment process.
Market Fluctuation — Not As Uncommon as You May Think …
We have all been reminded, recently, that the stock market is a volatile beast. This is a fact investors often forget, especially in the good times. Some of you may be surprised to learn that from 1900 through 2013 there were 123 instances where the stock market (as measured by the Dow Jones Industrial Average) fell 10% or more. That’s about once every year.
Famed investor Peter Lynch once explained that events occur all the time. They could be hurricanes, wars, political instability, currency or bank crises. All of them make investors nervous and cause market volatility. While it does get nasty it shouldn’t cloud your judgment about thinking long term. The key organ in investing is your stomach. Most people have the brainpower, but not everyone has the stomach for it.
A Look at Historical Trends — U.S. Gross Domestic Product …
Looking at the U.S., the 20th century was unbelievably good. Gross Domestic Product per capita (a measure of all business activity divided by the population of the U.S.) went up every single decade, including the decade of the depression where it was up 13%. In all, the GDP per capita of the country went up 620% over the course of 100 years.
When it comes to the stock market every $1,000 invested and held to the end became $180,000 — a very satisfactory result. But, 44 of those years were three big bull markets and 56 of them were rough periods where, in aggregate, the market was actually down. Performance was incredibly volatile and, as you can imagine, most investors did not see those large gains.
The figure below shows U.S. GDP per capita and the Dow Jones Industrial Average through the 20th century. The blue line is GDP and the red line is stocks.
As you can see for the 21 years from 1900 to 1921, the Dow hardly moved, while GDP was making solid advances. Then from 1921 to September 1929 the market went from 71 to a high of 381 – a 500% increase. Obviously the well-being of the country did not go up 500% in that short time.
Just when investors were feeling most positive about the market in 1929, the Dow turned. By 1948, 18 years later, the stock market had declined from a high of 381 to 180. What most investors at the time failed to see was that the per capita GDP had been steadily rising — up almost 60% over the same period.
History has shown over and over again that the stock market can, for long periods of time, move in ways that have nothing to do with fundamentals. The reason is, the stock market is populated with human beings, with emotions and a herd behaviour. The idea of a perfectly efficient market is simply not possible.
Just look at the period from 1964 to 1981, where the Dow went exactly nowhere. After 17 long years investors had made no money. By 1980 most investors said stocks were a lousy place to be. Even pension funds — considered the most sophisticated of investors — were putting record low amounts of money into stocks. Again GDP had been surging ahead, interest rates, corporate profit margins and other factors were also more favourable. This mattered very little to these investors.
The following period, from 1981 to 2000, the Dow went up 1,133%. With dividends, a $1 million investment in the Dow would have become $22,758,960.
In 2001 Warren Buffett gave a speech to University of Georgia students on this very topic. I encourage you to watch the video here.
Buffett concluded that the level-headed, unemotional investor can take advantage of this volatile market to make big money. This may be true. I simply believe knowing the facts and a little history may be the best tool we have to help us understand the market and maintain clarity during periods of uncertainty.
CIBC Wood Gundy is a division of CIBC World Markets Inc., a subsidiary of CIBC and a Member of the Canadian Investment Industry Regulatory Organization of Canada. If you are currently a CIBC Wood Gundy client, please contact your Investment Advisor. Jamie Grundman is an Investment Advisor with CIBC Wood Gundy in Toronto. The views of Jamie Grundman do not necessarily reflect those of CIBC World Markets Inc.