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Friday, April 23, 2010

Unexciting expectations.

The stock market is a puzzle to most people. It zigs when everyone expects it to zag. It goes up on a bad unemployment report one day, then down when a report shows the economy is booming the next. It can leave us frustrated and angry on such occasions.

Although I agree it's a mystery in the short term, it's much less of a puzzle over the long term. At any point in time, it's possible to provide a reasonable range of returns for the next 5 or 10 years. The market doesn't end at a precise point over that time frame, but it does follow a logical path.

The market's underlying logic is based on fundamentals. They include: 1) profits, 2) growth, 3) dividends and 4) how much people are willing to pay for those three. The first 3 are straightforward; the third is erratic over the short run, but tends to revert to the mean over the long haul.

No crystal ball needed. No eye of newt, or rat tail. Just an understanding of the underlying logic and the discipline to realize that's where things will head over time.

What does my "crystal ball" show for market returns over the next 5 to 10 years? A pretty unexciting picture. Over the next 5 years, I expect returns of -4% to 11%, with an average tendency of 3%. See, unexciting. Over the next 10 years, it looks like 2% to 10% annualized returns with an average of 6%. Assuming inflation in the 3% range, that leaves 0% to 3% real, annualized returns over the next 5 to 10 years. Probably a lot less than most people are expecting or planning.

The path to that range and those averages is likely to be much more "exciting." If anything was learned over the last 2 1/2 years, it's that a boring long term path may prove terrifyingly exciting over the short run.

The market peaked in October 2007, plunged 57%, then climbed 79% to today. That's a 23% decline from fall 2007, and an annualized loss of 10% a year. Our path going forward may prove similarly breath-taking.

How do you avoid such "excitement"? Don't invest in the stock market. But, beware that inflation and defaults may make cash and bonds just as terrifying.

Is there any way to do better? Yes, but it means being more selective than buying "the market." Over almost any time period, some stocks do well. Finding them isn't an easy task, but it can be done. Wal-Mart and Johnson & Johnson, which I held for clients and myself during the downturn, did quite well.

This doesn't eliminate risk, or volatility. That's just part of life (and especially investing). But, better long term returns are possible. They're unlikely to shoot out the lights, but they can put you in a much better position when the next real bull market begins.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

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