Underperforming the Market

[sutherland]

Have any of you noticed, as I have recently, that you are underperforming the market? The S&P average hovers around 10 percent, long term.  I read the AAII Journal, listen to Market Place on NPR radio daily, read the blogs, etc.  Any advice for me? Thanks

[+ nycman]

Two words….Index Funds.

I don’t under perform or out perform the market…..because I AM the Market!

[+ stevenkesslar]

This is funny.  I just posted an off topic video by Mike Green in a different thread.  But it is on topic here.

Green's point is that now that "brainless" (his word) passive investing ....  like S & P 500 index funds ... has taken over roughly half the market, it has made life hard for active managers.  Boo hoo!  And added volatility to the market.  He likens it to a car driving up a hill without brakes.  Which could land us in something like another subprime crisis when we get to the downhill portion of the ride. 

He makes some good arguments, if you are interested and have an hour.  But I don't buy it.  The key point he never really addresses is why the market of stock buyers are speaking with their pocketbook.  Three main reasons.  It is more profitable.  It is relatively safer.  (We hope.)  And it is easier.    And Green's argument doesn't quite make sense.  If passive investing is brainless, and active managers are so smart, why are they having such a hard time consistently outperforming brainless passive investors buying the S & P index funds?  🤔 

Not all funds, of course, are index funds.  But a lot of them are.  I'm newly - like as of of a few weeks ago - into funds like SOXL and FNGU that are outperforming the market ........... for now.  As I've said a few times, a nephew threw caution to the wind last October and is up about 300 % on one of those leveraged tech funds.  Check back with me in a year, if we are in a recession.  I am fully aware they will outperform the market on the downside as well.  To use Green's analogy, I'm simply assuming I am smart enough to jump out of the car when it starts going downhill without brakes.  To complete the analogy, buying into the S & P 500 ensures you at least have some brakes on the way down. Unfortunately, it still won't be a very pleasant ride.

Here's two other words ........... Berkshire Hathaway.  I don't own the stock.  But it is one example of a way to beat the market consistently, by a gigantic amount.  I do what I consider a form of Buffet Lite.  Like I own Apple stock, which is Berkshire's largest holding.  It has wildly outperformed the market for decades.  Will that continue into the future?  Who knows.  What I do know is I am not as smart as Warren Buffet.  So I figure if it is good enough for him, it is good enough for me. 

Green talks about the negative aspects of this behavior.  But I think the positive side is that it rewards the winners, like Apple.  And keeps or puts them in indexes like the S & P 500.  Or some other index fund that will consistently produce good returns, like what you state.   When they become losers, they are dumped.  Which is why vast numbers of people keep buying them, as the chart above demonstrates.

S&P 500: $100 in 1957 → $65,980.22 in 2023

Here's a fun little tool I found.  You can plug in any number you invested, any year you invested it, and see what you would have made, including dividends, if you bought the S & P 500 instead.  It makes it very easy to see why people like index funds such as the S & P 500.

Two other words, which send most people, including apparently @Rod Hagen, screaming into the night ............. real estate.  When I enter any down payment I made on any home in any year into that, I did way better than putting it in the S & P 500.  That's thanks to the magic of leverage.  Since I get 100 % of the appreciation even though I only put 20 % into it.  Most normal people would consider this worse than driving down a hill in a car without brakes.

I'll add one other test I just ran last week relating to the S & P 500.  Precisely because I'm trying to decide how much risk I am willing to take in index funds versus tech ETFs versus some individual stock like Apple.  I looked at the decade from 2000 to 2010.  Because I figured that for any "buy and hold" strategy that's about as bad as it can get.  So you can use that tool above to calculate that if you dropped $10,000 in the S & P in January 2000, you would have had a whopping return of 1 % a year by 2010.  That was actually good, I thought.  Dividends is what got it to at least break even, since in 2010 the index was still below where it was a decade earlier. 

Then I took the six stocks I own right now that were around in 2000 and did a simple calculation.  What if I bought each one at the very market top in 2000, and held them until the end of 2010?  Three tech stocks (like Intel) were way down.  Two were up a bit up:  Baxter and Raytheon.  But I would have doubled my money, even during a really crappy bear market, simply because I owned Apple.  AAPL peaked at a split-adjusted price of $1.29 or so in 2000 - can you believe it? - and was worth $9 at the end of 2010.  Can you believe it?

I knew someone who helped manage a venture capital fund for a long time.  If I understood him correctly, this is basically how venture capital fund offerings work.  In any offering they plan on having some losers, and some modest winners.  The most important thing is they hope to have one big winner, which makes all the difference.  So if you want to outperform the S & P 500, that's probably the thing to do.  Pretend you're a venture capitalist and try to pick a big winner.  Good luck.

 

Edited September 4, 2023 by stevenkesslar

[+ stevenkesslar]

10 hours ago, sutherland said:

Have any of you noticed, as I have recently, that you are underperforming the market?

I am posting this question separately since I didn't want it to get lost in my verbosity.

You now have two answers saying:  go index fund.  But what are you invested in, and why do you think it is underperforming?

[sutherland]

I have ETFs that track the big indexes like S&P 500 and Russell 1000.  When I click on the "performance" tab on my Fidelity online brokerage account I see that my 5-year return is - 0.29%.  I admit that 5 years ago I was 'green' and made some common errors.  My year-to-date return is 5.21%. 

I own a lot of the ETF 'VOO' (which Warren Buffett himself advises)

[+ stevenkesslar]

On 9/3/2023 at 12:26 PM, nycman said:

Two words….Index Funds.

I don’t under perform or out perform the market…..because I AM the Market!

So we mostly agree.  But since this is not Twitter, and part of my job around here is to be verbose, I'll complicate things.

Arguably, you are not the market.  You are a handful of volatile tech stocks. 

Your mini-me is the market, which is everything else.  🤔

I brought Mike Green up because I think he is at least partly right.  Index funds (or passive investing) have elements of driving a car up a hill with no brakes.  It probably has helped inflate both the price and PEs of the stocks above.  Although the same thing happened to Intel and Microsoft and Cisco in the late 90's, when passive investing was a small share of the market.  Either way, as we've seen many times in the past, riding a car down a hill without brakes is a very different experience.

While Green sees passive investing as dangerous, there's one thing about it I see as a big positive.  It is almost patriotic.  I have read critics say that Americans are investing in gaming platforms, and things like Google that basically help you find porn online.  While China is building the best electric cars and AI technology that will run the world decades from now.  I don't buy it.  That chart above is proof.  Index funds tend to plow capital - arguably too much - into the most cutting edge and innovative technologies of the future.  But, as Warren Buffet says, lots of people lost fortunes eventually by investing in the cutting edge technologies of the past:  railroads, airplanes, the transistor.  Speaking of people who have lost fortunes, if Jack Ma is the future of China, which he used to be, China now has a big problem.

Some book on investing I read years ago went through various types of investments, including real estate, in simple terms.  I think, ballpark, it said something like homes appreciate 5 % a year on average, versus 10 % growth for stocks, including dividends.  So your best simple bet is to go with stocks, and an index fund.  My reaction to the book was thanks, but no thanks.  Thanks to the magic of real estate leverage, I way outperformed stocks for decades in a row.  For most people who only own their own home, like my deceased Mom and Dad, it still ends up being the biggest asset they own.  Now that I am selling rental homes I'm trying to figure out whether, or even if, the stock market can make returns that are in the same ballpark.  So index funds like the S & P 500 or tech-laden ETFs are my default moving forward. 

That said, on a practical basis, there's not a huge difference between VOO or similar funds which are the S & P 500, and  FNGU or SOXL, which are ETFs loaded with the stocks in the pie above.  With FNGU and SOXL, which are 3x leveraged, the drive up the hill will be faster and more fun, brakes or not.  On the way down, I am planning to jump out of the car, though.  If I don't survive, I'll miss y'all.  😉

My Millennial nephew has suggested that his generation will be the true guinea pigs for passive investing.  I think he is right.  My parents mostly avoided stocks.  Except for my Mom who followed a very good stock tip to buy Baxter. Boomers and Gen X, in my family, mostly play with stock picking or have had active managers, at least in the past.  Funds like Magellan and Peter Lynch, or Buffet and Berkshire, have shown they could make 30 % a year for a very long time.  If passive investing ends up being a car without brakes, Millennials will be the ones who the crash permanently injures.  

If anyone is interested in engaging on a longer term and theoretical level, here's another way to look at whether the market is underperforming or overperforming:

Around 9/11 I had a discussion with a stock broker, who I'd invited to speculate about when and where the 2000 bear market might end.  He said that at some point the market would hit a single digit PE and bounce back up.  And then we'd know the bear market was over.  Over two decades later, that still has not happened.  So if stocks have been overvalued for almost every year since the early 90's, can they really be overvalued?  And if we have been in a bubble, or extreme bubble, maybe half the time since the early 90's, how can it even be a bubble?  That sounds like "this is time is different."  But, 23 years in, this century and the last decade of the past century have been consistently different.

What Green got me wondering is that maybe it's less about the huge money flows into passive funds, and more about the even bigger flows into the stock market, period.  Including stock buybacks.

Those two charts show two different aspects of the huge increases in flow.  The first one is about the growth in online retail trading. The most interesting thing about the second chart (which stops at 2000) is the explosion of the Nasdaq.  It started in the early 1970's as a tiny fraction of the NYSE, and ended up surpassing it by the end of the century.  Same time period as when stock buybacks made a roaring comeback (1982) and overall stock markets PEs soared to heights never seen before.

I Googled to see if there were theories someone like Green have online about the PE impacts of overall stock volume, not just passive investing.  The thing that made the most sense to me is William O'Neill's (Investor Business Daily) stuff about how picking individual stocks with low PEs makes little to no sense.  Because often the stocks that perform best have what seem like nosebleed PEs.  Even at the start of what end up being massive price runs.  Nvidia is now a perfect poster child for the point O'Neill was making.  When I checked a few months ago it had a PE of 221.  Now, thanks to its last over the top earnings report, the PE is "only" 114.

What all this makes me wonder is whether a set of concepts based on how stocks worked back in the 1970's, when the Nasdaq was newborn, even still apply.  Passive investing is certainly one way in which everything has changed.  If I go back to the idea that at some point a very long bull market will end, and the car with no brakes is probably bound to crash into a wall with a single digit PE, that's only a little better than a ticket on the Titanic.  The same Millennials who felt screwed by the Great Recession will feel even more cynical.

This Shiller version of the S & P 500 PE is my favorite market PE measure that I look at once in a while.  Since it averages out long term (10 year) market PEs.  The current PE is roughly double the historical mean and median.  Which suggests that if Green is right, and passive investing is a car driving up a hill without brakes, we might be setting ourselves up for a hell of an awful ride.  Worse, if I only look at 1880 to 1980, right now we are at the top of the hill.  And the only time we were this high, in 1929, we were actually at the start of one of the worst crashes ever.

If I focus on 1990 to 2023, the current PE of 30ish is smack dab in the middle of a "normal" range of 15 to 45.  Which maybe makes sense, if the market is increasingly structured in a way that elevates the most profitable tech stocks with the highest PEs.  Which it then tends to push higher.  Whatever some stock broker at the end of his career told me two decades ago, that's not the world Millennials investing in index funds have ever lived in.  Plus, it looks like the car is in fact still going up the hill, albeit with some bumps along the way.  Who knows where the top of the hill even is?  But if we're using Shiller's PE as a map, there is reason to think we potentially have a long way up to go.

To make one last use of Green's analogy, you can do okay for a long time in a car without brakes.  It still moves.  You can't run a car without gas.  (Well, Elon Musk can.)  The nice thing about index funds and passive investing is it's like having a massive, growing, and permanent gas station strapped on to the fuel tank.  It doesn't guarantee the car will always go up, as that retail trading chart above shows.  But what we know right now is we are going up.  And people are constantly putting massive amounts of gas in the car.  And we are as far from the most recent top as we are from the most recent bottom. 

I'm not particularly scared about the brakes right now.

 

 

Edited September 7, 2023 by stevenkesslar