We’ve been taught that long-term investing in the stock market will provide market returns above inflation. For large periods of history, this simply has not been true.
If we look from 1929 onward, the Dow Jones Industrial Average returned about 9% annually, including dividends. Thus, if we invested $842 in 1929, it would have become $1,000,000 in 2010. Likewise, an investment of $18,678 in 1970 would have become $1,000,000 in 2010. But what’s really behind this growth pattern? Using a compound growth calculator for the Dow, we can take a closer look at stock market returns. Clearly, the rise has been all but a straight line, with much of the growth coming during a relatively brief 30-year period.
And that growth is only half of the story. To measure the true purchasing power of our investments, we need to compare it to inflation. "Truth about inflation" (below) includes monthly consumer price index (CPI) data provided by the Department of Labor Statistics. However, the CPI has been recalculated over the years for both economic and, some would say, political ends. The chart also includes an alternate CPI measure calculated by ShadowStats.com (SGS). The alternate CPI is an attempt to correct for methodological changes to the standard CPI over the decades.
The difference is striking. According to the CPI, $1 in purchasing power in 1970 would require $5.80 now. According to the alternate CPI, it would require $20.92 now. During 1970-2000, $1 in the Dow would become $53.54, with more than 35% of that being dividends. More recently, the situation isn’t so rosy. Using the standard CPI, January 2000’s $1 of purchasing power would require $1.34 now and $2.86 using the alternate CPI. Stocks? They returned only 1.36% over this period—around the official rate of inflation but less than half the real rate.
For those recently retired, consider yourselves lucky. Most likely, your portfolio benefited greatly from the extraordinary 1970-2000 period. For those a decade or more away, the prospect of a 15- to 20-year period of sideways returns should be a wake up call. Buy and hold won’t cut it. We will attempt to find out what will by taking a closer look at some of history’s more significant bear markets. Through them, we will form the premises that will be the foundation of a modern systematic solution to long-term active investing.
Crash of 1929
During the 1920s, the stock market was a good investment, and by 1928, it was in full bloom. By then, Americans of all social backgrounds began accessing the stock market. Many started buying stocks on margin, with as little as 10% down.
On Sept. 3, 1929, the stock market peaked with the Dow closing at 381.17. After two days, the market started to fall, though not steeply at first. Stock prices oscillated through September and October until Oct. 24 before a slight rally prior to Oct. 28. This shocked speculators into another selling spree, banks did nothing to stem the panic, and the Oct. 29 crash was the result. Prices fell, and a steady slump set in for two years. On July 8, 1932, the Dow closed at 41.22, the market’s low point.
The economy was wrecked, companies were ruined, life savings were gone, and faith in banks was destroyed. The Great Depression, worsened by slack monetary policies and the subsequent misappropriation of capital based on cheap money, was well on its way.
In 1929-1933, U.S. gross domestic product (GDP) declined by 33%, general unemployment rose to 25% and industrial unemployment rose to 35%. After the 1932 election, President
Franklin D. Roosevelt’s unprecedented recovery plan, The New Deal, ushered in reforms, relief and recovery. A slow but brief upturn set in through 1937, when weakness returned and unemployment rose, sparked by higher taxes and the Federal Reserve reducing the money supply in 1936-37. The economy did not recover to pre-Depression levels until the onset of World War II.