Is long-term or short-term investing most lucrative? Traders, or market timers, are those who prefer entering and exiting stocks, options, futures, commodities and the like in short order by analyzing charts, sentiment and news. Traders aim to make short-term profits that exceed losses; no profit is too small, but the real money is made from large scores. In the fast paced world of professional trading, expert traders establish price targets for both potential gains and losses at the onset of each trade, and once a trade is on the books, it is constantly monitored. Most traders use leverage to amplify results; the idea is to keep losses at a minimum and to let the gains run. If traders see markets positively, they will take a position on the long side; if they believe the market is about to fall, they will go short, betting on the downside. For professional traders and aspiring amateurs alike, the temptation of matching wits and dollars against the sharks of Wall Street can be exhilarating.
No one really knows whether stocks will go up or down on any given day. If anyone actually knew the direction the market was heading, they would hit the jackpot. Every day, media personalities rave and rant about stocks to own and those to shun; it’s like going to the fair where the carnival barker yells, “Step right up and take your chances; there’s a winner every time!” The carny is correct; there are winners all right, but there are also losers. Trading stocks is far more expensive than carnival charades. For some, an infinitesimal few, effectively trading investment markets can be exceedingly profitable. For most, everyone else, day trading and the like is pure speculation and heedless gambling. There are millions of do-it-yourselfers buying and selling securities aggressively via their mobile devices. Unfortunately, these impulse players are doomed to eventually lose most of their money. Why? It’s because they are matched against shrewd financial wizards, hedge-fund war chests, mathematical algorithms, artificial intelligence, arbitragers, derivative experts and Wall Street sharks. Most individual investors lack the nerve, temperament, intel, technology, bank accounts, margin rates, efficiency and instincts necessary to win. Moreover, execution costs and federal taxes associated with short-term trading are killer.
Buying and holding stocks in many ways has lost its appeal to younger generations. Nouveau investors are searching for the next hot tip, penny stock, or trading program to hit it big, quick. The buy-and-hold strategy is considered old school, and is in direct opposition to today’s nanosecond attention span, hyperactive, speculative trading herd. Yet, buy-and-hold investors that have exhibited a disciplined approach to buying and holding blue chip stocks over the long-term have been richly rewarded over the past 117 years. The DJIA rose from 40 in 1900 to over 21,000 in March of this year. That’s a 5.1% annualized return in price appreciation; add in reinvested dividends, and the compounded rate for the DJIA jumps to 9.77%. Sounds easy enough. Is it?
During the Roaring Twenties, the economy soared. Folks migrated in herds from rural areas to urban cities after World War I in search of a better life, and they found it. New technologies such as cars, appliances and mass produced products ignited consumerism. There were more jobs, more people working, and more money being earned than ever before. Americans were flying high and investing their money in the stock market. Credit during this era was abundant, enabling individuals to borrow and buy most anything, including stocks. A person with $5,000 could buy up to $50,000 worth of stock. It was the greatest period in America’s history, and euphoria was manic. Stock prices continued their ascent; as prices increased, speculators pressed their bets, until the bubble finally burst in 1929. By 1932, stocks fell to 41.22, down almost 90% from the 381.17 peak. The economy was dead in the water; job destruction was unprecedented; industry was brought to a standstill; bankruptcies crippled the country and America fell into a dark depression. Buying and holding was painful during this time period; it took over 25 years for the stock market to reach its 1929 highs.
The years from the mid-60s to the early 80s were another rough patch for buy-and-hold investors. The Vietnam War, OPEC oil shocks, Watergate, stagnant wages, and rising interest rates held stocks in check for 16 years. There were five bear markets during this span, with an average decline of more than 31%.
At the turn of the millennium, investors were once again ebullient. Fed Chairman Alan Greenspan characterized the psyche of the times as “irrational exuberance.” The internet and everything dot-com was the rage. Companies were going public as fast as Wall Street houses could manufacture the offerings. In less than six months, the Nasdaq Composite rose by 100% and was priced at 400x earnings. It was a market for ravenous gamblers; the odds were much better in Vegas. As to be expected, things didn’t end well; the Dow plunged by 38% and NASDAQ technology sector lost 80% of its value. Investors abandoned stocks, choosing to move their money into real estate and the housing market by borrowing money. From 2007 to 2012, the bottom fell out of the housing market. Home prices sunk by 33% across the nation, sending the country into a severe recession. Pain and anguish was the worst since the Great Depression in the 30s. There were two grueling bear markets during this “lost decade” with average losses of 46%. It was a very difficult time for buy-and-hold investors.
It is said that tough times call for tough actions, and good times call for even tougher actions. History is just a guide; what happened in the past, may not happen in the future. The Maven-of-Manhattan, Sam Stovall, informs investors that since 1945 the S&P 500 posted average gains of 6.8% during the “Sweet Six” months of November through April, but only 1.4% during the “Sour Six” months of May through October. The S&P 500 currently sits at 17.6x forward 12 month earnings, and trades well above its 5, 10, and 25 year averages of 15.0, 13.9 and 16.5 respectively. Averaging the P/E ratios of these three time periods prices the market 16.3% above fair value. What’s an investor to do? Considering the history of the “Sour Six,” now may be a decent time to rebalance existing assets, reallocate to alternative investments, or lessen portfolio risk until valuation metrics moderate, either by price or time.