One contributing factor to the long-term positive stock-market performance that made the passive buy-and-hold argument so easy to accept was the Baby Boom that followed the Great Depression and World War II. This same phenomenon might also lend credence to the prospect that passive positive stock returns are about to end.
As families grew following WWII, so did consumption. Better education and employment resulted in even higher corporate revenues. Markets also grew as per the needs and expectations of the new generation. By the 1960s, Baby Boomers had come of age, bringing the era of post-materialism. Birth rates dropped as more women entered the work force. Spending increased, reducing public investment, which affected prosperity. By the 1970s, the economy slowed down drastically as compared to the 1950s and 1960s. Nevertheless, asset accumulation was highest among this generation.
It’s no secret that Baby Boomers and subsequent generations had fewer children than the generation before them, resulting in a relatively older population nearing retirement age straining the economy in terms of pensions and social security. This requires more relative funding from the younger generation, which in turn must lower its economic living standards to support the larger, retired population.
One suspicion is this lowering of consumption will lead to a long period of slow economic growth. Indeed, it now seems unlikely that the 5% U.S. gross domestic product growth since 1947 will continue. The analog is Japan, which has found itself in a similar situation. A decade or more of effectively flat stock market returns could be in our future.
Over time, the proponents of buy-and-hold were not above adjusting the fundamental approach. For example, one change was to support spreading funds across different sectors, which smoothed out the performance over the economic cycle. However, depending on how you adjust the allocations, diversification smells a lot like market timing. After all, “buy and hold the right mix of markets” is quite far from “buy and hold.”
Ironically enough, the final nail in buy-and-hold’s coffin might be rooted in the market’s inherent unpredictability. One argument for buy-and-hold is that you don’t know when big returns will occur, and if you miss the biggest two to three up days for the year, then you have missed the returns for that year. This makes sense until you realize that there are bigger down days than up days.
Since 1901, there have been about 10% more 2%-3% daily down moves than daily up moves for the Dow Jones Industrial Average. This edge for down days increases as we look at larger moves. Thus, the reverse of the argument about missing the biggest few up days per year is more likely: “If you miss the largest two to three down days each year, you would more than double your returns.”
