This morning, I gave a presentation for iFAST Global Markets’ Virtual Symposium – Strategies to Build Wealth During the Bear Market event. I would like to thank the iFAST Global Markets team, in particular Ko Yang Zhi, for their invitation. The title of my presentation is the same as the title of this article you’re reading. You can check out the slide deck for my presentation by hitting this orange button:
You can also find my speech, along with the accompanying slides, below!
Presentation
[Slide 2] Hi everyone, I’m Ser Jing. I launched Compounder Fund, a global equities investment fund, July 2020 together with my friend Jeremy Chia. The both of us also run an investment blog called The Good Investors, with the URL (www.thegoodinvestors.sg). Prior to Compounder Fund and the blog, I was with The Motley Fool Singapore from Jan 2013 – Oct 2019. For those of you who may not know, The Motley Fool Singapore was an investment website and we specialised in selling investment research online.
[Slide 2] During this presentation, I’ll be sharing myths regarding the stock market that I commonly read or hear about. These myths are dangerous if they’re not debunked because they can harm your long-term investing returns by influencing your investing behaviour in negative ways. During the presentation, I’ll need your participation. There will be a few questions I’ll be asking, and I need your help to answer them. I’ll be covering nine myths in all, and there will be some time for a Q&A at the end. With each myth that I debunk – with factual data – I’ll also discuss a key lesson that we can learn from each of them.
[Slide 3] Before I dive into the presentation, nothing I say should be taken to be investment advice or a recommendation to act on any security or investment product. I may also have a vested interest in the stocks mentioned during this presentation
[Slide 4] Let’s start with the first myth. Imagine that you’re now back in 1992 and you found a country that had a GDP (gross domestic product) of US$427 billion. You also have a perfect crystal ball that’s telling you that this country’s GDP would go on to compound by 13.7% per year till 2021, ending the year with US$17.7 trillion in GDP. Take a second to think if you would want to invest in the stock market of this country in 1992? Note that these are all real figures.
[Slide 5] The country I’m talking about here is China and if you said yes to my question, a dollar that you had invested in the MSCI China Index – a collection of large and mid-sized companies in the country – in late-1992 would have become roughly… a dollar by October this year. You heard that correctly: Chinese stocks have been flat for 30 years despite a 13.7% annualised growth in GDP over the same period. The reason is because stocks ultimately go up if their underlying businesses do well.
[Slide 6] And in the case of China, you can see that the earnings per share of the MSCI China Index was basically flat from 1995 to 2021.
[Slide 7] So the first myth I want to debunk is that a country’s stock market will definitely do well if its economy is growing robustly. And the lesson here is that the gap between a favourable macroeconomic event and the movement of stock prices can be a mile wide.
[Slide 8] Now for the second myth. Let’s go back in time again, this time to September 2005 – in case you’re wondering, we’ll be doing quite a bit of time travelling in today’s presentation. You’re in September 2005 now and you can see that gold is worth A$620 per ounce. The perfect crystal ball you had in Myth 1 is now telling you that the price of gold would climb by 10% per year to A$1,550 in September 2015. The golden question facing you now in September 2005 is this: Do you want to invest in Australian gold mining stocks for the next 10 years?
[Slide 9] If you said yes, you would be sitting on a loss of more than 30%. The S&P / ASX All Ordinaries Gold index, an index of gold-mining stocks in Australia’s stock market, fell by 4% annually from 3,372 points in September 2005 to 2,245 in September 2015.
[Slide 10] So the second myth is this: You should definitely invest in a commodity-producer’s stock if you’re sure that the price of the commodity will rise. The lesson here is the same as the first myth’s: The gap between a favourable macroeconomic event and the movement of stock prices can be a mile wide. In that mile are things like the quality of the business, the capability of the management team, the balance sheet strength of the company, and so on.
[Slide 11] Moving on to the third myth, I need your help to choose between two groups of real-life US-listed companies that you would prefer to invest in if you could go back in time to 2010.
[Slide 12] The first group comprises Company A, Company B, and Company C. This chart shows their stock prices from the start of 2010 to the end of 2021 – Company A is the purple line, Company B is orange, and Company C is blue. More specifically, the chart shows the percentage declines from a recent high that each company’s stock price had experienced in that timeframe. The chart looks brutally rough for all three companies. Their stock prices declined by 20% or more on multiple occasions from 2010 to 2021. In fact, Company B’s stock price had fallen by 40% from a recent high on four separate occasions, and Company C even suffered an 80% drop in 2011. Moreover, their stock prices were much more volatile than the S&P 500; the S&P 500 is a major stock market index in the USA and it experienced a decline of 20% or more from a recent high just once in early 2020.
[Slide 13] The second group of companies are Company D, Company, E, and Company F. This table illustrates their stock prices and revenue growth from the start of 2010 to the end of 2021, along with the S&P 500’s gain. The second group has generated tremendous wealth for their investors, far in excess of the S&P 500’s return, because of years of rapid business growth.
[Slide 14] This chart is a pictorial representation of the stock price gains that Company D, Company E, Company F, and the S&P 500 have produced.So take a second to think about which group you would like to invest in. As a quick recap: The first group had experienced severe volatility in their stock prices in the 2010-to-2021 time frame, often falling by huge percentages.
[Slide 15] I’m guessing that most of you would prefer to invest in the second group. But here’s what’s interesting: Both groups refer to the same companies! Company A and Company D are Amazon; B and E are MercadoLibre, and C and F are Netflix. Amazon and Netflix are likely to be familiar to all of you watching this, but MercadoLibre is not – it is an e-commerce and digital payments giant that focuses on Latin America.
[Slide 16] The third myth is that great long-term winners in the stock market will make you feel comfortable on their way up. But this myth couldn’t be further from the truth. Even the market’s best winners will make you feel like throwing up as they climb over time and there are two lessons here: (1) Volatility in the stock market is a feature and not an anomaly, and (2) The route to huge gains in the stock market will feel like a sickening roller-coaster.
[Slide 17] We’re now at the fourth myth, and it relates to something interesting about the stock price returns and business growth of Amazon, MercadoLibre, and Netflix. This table shows the revenue growth and stock price movement for all three companies in each year from 2010 to 2021. You will notice that the trio have each: (1) exhibited excellent revenue growth in each year for the period; (2) underperformed the S&P 500 in a few calendar years, sometimes significantly; and (3) seen their stock prices and business move in completely opposite directions in some years. But yet, all three of them have produced excellent business growth with matching stock price returns, as I discussed in Myth 3.
[Slide 18] The experience of Amazon, MercadoLibre, and Netflix are not isolated examples. In fact, Nobel-prize-winning economist Robert Shiller once published research in the 1980s that looked at how the US stock market performed from 1871 to 1979. Shiller compared the market’s performance to how it should have rationally performed if investors had perfect knowledge on the future changes in its dividends. The result is the chart you’re looking at now. The solid line is the stock market’s actual performance while the dashed line is the rational performance. Although there were violent fluctuations in US stock prices, the fundamentals of American businesses – using dividends as a proxy – was much less volatile. The legendary investor Ben Graham has a beautiful analogy for the stock market, that it is a voting machine in the short run but a weighing machine in the long run. Plenty of shorter-term voting had taken place in the US stock market over the course of history. But importantly, the weighing scale did function beautifully. From 1871 to 1979, historical data on US stocks maintained by Shiller show that the S&P 500’s dividend and price had increased by 2,073% and 2,328%, respectively.
[Slide 19] So the fourth myth is this: If a stock’s underlying business does well every year, the stock’s price will also do well each year. In fact, and this is the lesson: A company’s stock price can exhibit stomach-churning short-term volatility even when its underlying business is performing well, but in the long run, business fundamentals and stock prices do match up nicely.
[Slide 20] We’re at the fifth myth now, and I need your help to quickly think about this question: We’re now at the start of the year 1990 – how do you think the US stock market will fare over the next five years and the next 30 years, if I tell you that all three of the following will happen during the year: In July, the USA will enter a recession and a month later, the country will fight in a war in the Middle East and the price of oil will spike?
[Slide 21] Turns out, the S&P 500 was up by nearly 80% from the start of 1990 to the end of 1995, including dividends and after inflation.
[Slide 22] From the start of 1990 to the end of 2019, US stocks were up by nearly 800%.
[Slide 23] What’s also fascinating is that the world saw multiple crises in every single year from 1990 to 2019, as the table here illustrates. Yet, the S&P 500 had steadily marched higher in that period.
[Slide 24] The myth here is that stocks can only do well during peaceful times. But the truth – and the lesson – is that uncertainty is always around, and disasters are always happening, but that does not mean we should not invest as stocks can still do well even in the face of trouble.
[Slide 25] For Myth No. 6, let’s consider the importance that some of the best investors in the world place in trying to predict the short-term movement of stock prices. We can use Peter Lynch and Warren Buffett as examples. But first, I’ll quickly run through why the both of them are widely considered to be investing greats. Lynch was the manager of the US-focused Fidelity Magellan Fund from 1977 to 1990. During his 13-year tenure, he produced an annual return of 29%, nearly double that of the S&P 500. Meanwhile, Buffett has been in control of his investment conglomerate Berkshire Hathaway since 1965. From then to 2018, he grew the book value per share of Berkshire by 18.7% per year by using its capital to invest in stocks and acquire companies with outstanding businesses. Over the same period, the S&P 500 compounded at less than 10% annually.
[Slide 26] So how do Lynch and Buffett incorporate short-term predictions on the stock market in their investing process? They don’t. In an old interview with PBS, Lynch said: “What the market’s going to do in one or two years, you don’t know. Time is on your side in the stock market. It’s on your side. And when stocks go down, if you’ve got the money, you don’t worry about it and you’re putting more in, you shouldn’t worry about it. You should worry what are stocks going to be 10 years from now, 20 years from now, 30 years from now.”
[Slide 27] Then there’s Buffett, who wrote a famous op-ed for The New York Times in October 2008, at the height of the Great Financial Crisis. In it, Buffett shared: “Let me be clear on one point: I can’t predict the short-term movements of the stock market. I haven’t the faintest idea as to whether stocks will be higher or lower a month or a year from now. What is likely, however, is that the market will move higher, perhaps substantially so, well before either sentiment or the economy turns up. So if you wait for the robins, spring will be over.”
[Slide 28] Myth No.6 is something I hear often, and that is that great stock market investors know exactly what’s going to happen to stock prices in the next month or year ahead. But as I’ve discussed, even the best in the business have no clue what stocks would do in the short run, and yet that did not prevent them from clocking incredible long-term returns. So the lesson here is that we can still achieve great long-term investing results even if we have no idea what the market’s going to do over the short run.
[Slide 29] The seventh myth involves stocks and recessions. What do you think will happen if you have perfect clairvoyance and are able to tell when the US economy will enter and exit a recession and thus sell stocks just before a recession hits and buy them back just before a recession ends?
[Slide 30] If you had this clairvoyance from 1980 to 2018, you would wish you did not have the special ability. According to research from Michael Batnick, a dollar invested in US stocks at the start of 1980 would be worth north of $78 around the end of 2018 if you had simply held the stocks and did nothing. This is the black line in the chart. But if you invested the same dollar in US stocks at the start of 1980 and expertly side-stepped the ensuing recessions to perfection, you would have less than $32 at the same endpoint. This is the red line.
[Slide 31] The seventh myth is that it is important for stock market investors to side-step recessions. But the data shows us an important lesson: Trying to side-step recessions can end up harming our returns, so it’s far better to stay invested and accept that recessions are par for the course when it comes to investing.
[Slide 32] Moving to Myth No. 8, when we’re in an economic downturn, I think it’s natural to assume that it’s safer to invest when the coast is clear. But the reality is that the stock market tends to recover before good news about the economy arrives. For example, if we go back to the most recent recession in the USA prior to COVID, that would be the recession that lasted from December 2007 to June 2009. In that episode, the S&P 500 reached a trough in March 2009 of around 680 points. Back then, the unemployment rate in the country was around 8%. But by the time the unemployment rate reached a peak in late 2009 at 10%, the S&P 500 was already around 50% higher than where it was in March 2009 and it has never looked back.
[Slide 33] So the myth here is that we should only invest when the coast is clear. But as the data shows – and to borrow a Warren Buffett quote I mentioned earlier, “if you wait for the robins, spring will be over.”
[Slide 34] And last but not least, we’re at Myth No.9, where it’s about interest rates and stocks. There’s plenty of attention being paid to interest rates because of its theoretical link with stock prices. Stocks and other asset classes (bonds, cash, real estate etc.) are constantly competing for capital. In theory, when interest rates are high, the valuation of stocks should be low, since bonds, being an alternative to stocks, are providing a good return. On the other hand, when interest rates are low, the valuation of stocks should be high, since the alternative – again, bonds – are providing a poor return. And falling valuations for stocks would then lead to falling stock prices. But the real relationship between interest rates and stocks is nowhere near as clean as what’s described in theory.
[Slide 35] Ben Carlson’s research has shown that the S&P 500 climbed by 21% annually from 1954 to 1964 even when the yield on 3-month Treasury bills (a good proxy for the Fed Funds rate, which is the key interest rate set by the USA’s central bank, the Federal Reserve) surged from around 1.2% to 4.4% in the same period. In the 1960s, the yield on the 3-month Treasury bill doubled from just over 4% to 8%, but US stocks still rose by 7.7% per year. And then in the 1970s, rates climbed from 8% to 12% and the S&P 500 still produced an annual return of nearly 6%.
[Slide 36] Meanwhile, data from Robert Shiller show that the US 10-year Treasury yield was 2.3% at the start of 1950. The yield reached a peak of 15.3% in September 1981. In that same period, the S&P 500’s price-to-earnings (P/E) ratio moved from 7 to… 8. That’s right, the P/E ratio for the S&P 500 increased slightly despite the huge jump in interest rates.
[Slide 37] It’s worth noting too that the S&P 500’s P/E ratio of 7 at the start of 1950 was not a result of earnings that were temporarily inflated, as can be seen by the trend for the index’s earnings per share in preceding and subsequent five-year periods.
[Slide 38] Then we have this chart, which illustrates the historical relationship that the S&P 500’s price-to-earnings (P/E) ratio has had with 10-year Treasury yields. It turns out that the S&P 500’s P/E ratio has historically and – noticeably – peaked when the 10-year bond yield was around 5%, and not when the 10-year bond yield was materially lower at say 3% or 2%.
[Slide 39] The ninth myth is this: Rising interest rates are definitely bad for stock valuations and thus stock prices. But what the evidence shows is that stock valuations and prices have risen over time even when interest rates have soared. So there are two important lessons here: (1) While interest rates have a role to play in the movement of stocks, it is far from the only thing that matters; (2) one-factor analysis in finance – “if A happens, then B will occur” – should be largely avoided because clear-cut relationships are rarely seen.
[Slide 40] I’ve come to the end of my presentation today and I’m happy to take questions!
Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life. I currently have a vested interest in Amazon, MercadoLibre, and Netflix shares mentioned. Holdings are subject to change at any time.
This was an excellent presentation. Thank you for sharing.
Hi Gerard, thanks for reading and for your kind words – Ser Jing