“Steve, I’m really interested in what you said last night,” my good friend Porter Stansberry said to me last week.
“You said there are two things that you believe about how markets work,” he continued.
Here’s what I had said: In the short run, markets continue doing what they’re doing. In the long run, markets revert back to their averages (or “mean”).
[ad#Google Adsense 336×280-IA]The recent housing boom and bust is a good example of both of my beliefs…
In the short run, home prices kept going up and up, in a self-reinforcing trend. But they couldn’t go up 10 times faster than incomes forever… so we had a bust.
Housing prices then went lower and lower, in a self-reinforcing trend.
Over the long run, the growth in house prices reverted back to its normal level.
“I’m not that interested in your short-run trends,” Porter told me.
“What I am interested in right now is your reversion to the mean stuff… We’ve just had seven great years in the stock market. What I want to know is, what happens to stock prices over history after having seven great years?”
Here’s exactly what has happened…
The following table shows what has happened to stock prices after seven great years and after seven bad years since the 1870s. (These are apples-to-apples comparisons… all the gains are annualized.)
Take a look:
I called the best 10% of seven-year periods “great” and the worst 10% of seven-year periods “bad.” (The last seven years barely made the cut in the top 10% of great seven-year periods.)
A few interesting things stand out…
After seven great years, it takes a very long time for stocks to return to “normal.” Returns aren’t back to normal even seven years later.
After seven bad years, you want to buy stocks immediately. One year later, they have been up double digits, historically.
You might say, “All right, Steve, but that’s going back to the 1870s… Times have changed.”
Times may have changed somewhat. But this basic story still holds true. Take a look at the results since the 1950s:
This next table is revealing as well…
It’s the percentage of the times that you made money looking ahead… after seven great years and seven bad years, since the 1950s. Take a look:
Look at the column for five years down the road…
Stocks were up only 42% of the time – five years later – if you bought after seven good years.
Stocks were up 88% of the time, five years later, if you bought after seven bad years. (Meanwhile, stocks were up 100% of the time seven years later!)
So Porter, I hope this helps answer your question…
In short, after seven great years, history paints a pretty grim picture looking ahead. Three years… five years… and even seven years down the road… you’re still looking at below-average returns, based on history.
As you know, I’m fighting this history…
I still believe we will see one last major blast to the upside before a long period of lean years kicks in.
Good investing,
Steve
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Source: Daily Wealth