Investors are taught that it’s more important to look to the future than to fixate on the past. But after a year when the Standard and Poor’s (S&P) 500 stock index suffered its worst calendar loss since the Great Depression, it’s understandable that investors want to know what went wrong with their portfolios.
The simple answer, of course, is that the collapse in the housing market sent the credit markets into a tailspin, which in turn pushed the economy into its deepest recession in a quarter century. That explains why stocks have been plummeting for at least a year.
But one could also argue that investors made things worse by adhering to some conventional wisdom rooted in the bull markets of the past quarter century. And some of those ideas may have run their course. To be sure, even the most experienced and skilled investors found few places to hide in this market sell-off. In fact, since the bear market officially began on 9 October 2007, almost all kinds of investment—domestic stocks, foreign equities, commodities, real estate and even many types of bonds—were slammed.
And in this harsh climate on Wall Street, investors may need to rethink some of their basic assumptions about certain asset classes and diversification. Here’s what investors have already found out the hard way:
Losses can be long term
Stocks can lose money, even for a decade. Anyone who was around during the bursting of the technology stock bubble in 2000 knows how much and how fast stocks can fall in a bear market. Yet even after that debacle, many clung to the belief that as long as they had a long-enough investing horizon—say, a decade—they would always come out ahead by being aggressive. Well, the current market slide has all but erased that thinking. It’s been about nine years since the tech wreck, and the S&P 500 remains 39% down from its peak back then (that’s not including dividends).
Sam Stovall, S&P’s chief investment strategist, says investors must be wondering how long the holding period must now be for this faith in stocks to hold true. “One thing I do know is that it’s not 10 years,” he said.
So what is the new answer? Looking ahead, investors need to understand that it could take as long as 20 years for stocks to recover fully from major downturns in a worst case. So investors who are nearing retirement—and don’t have that much time to recover from market losses—need to think twice about putting all or virtually all of their portfolios into stocks.
Remember that the S&P 500, on a price basis, went pretty much nowhere in the 16-year span from 1966 to 1982. And after the stock market crash of 1929, it wasn’t until 1947 that stocks started to surge for good, Stovall noted.
Stocks aren’t the only game
Diversification means owning different assets, not just different stocks. When virtually every type of equity was climbing a few years ago, investors were willing to diversify their stock portfolios—but not through different investments such as bonds. Aggressive investors argued that by adding emerging-market shares to a portfolio of domestic blue chips, they could derive a degree of diversification. And that is statistically true. What they didn’t realize—but have since found out—is that emerging-market stocks can’t shield a portfolio from losses if the broad market starts to fall. Only bonds can do that. And, in fact, during this downturn, only ultrasafe treasury bonds accomplished this feat.
Not only did emerging-market stocks fall more than domestic equities in 2008—the MSCI Emerging Markets index fell 54%, versus the 38% drop for the S&P—they lost their diversification power as well. In the two months leading up to November, the correlation between the emerging-markets index and domestic stocks jumped to 81% from 68%, according to S&P, as investors fled equities and moved to bonds.
Long live treasurys
There’s an argument for owning treasurys at all times, even though some investors have argued during the present downturn that they can find far more attractive yields through other investments. For example, the list of securities paying more than 10-year treasury notes includes long-term corporate bonds, municipal debt, high-yielding junk bonds and even stocks. The yield on the S&P 500, for example, is 3%, versus the 2.4% for 10-year treasurys.
And as this bear has shown, no investment can beat treasury bonds when it comes to protecting one’s portfolio in a downturn. In 2008, for example, the average long-term government bond fund returned at least 27%, as frightened investors drove up the value of treasurys. Almost every other bond fund category fell last year along with stocks—as fears about the credit market gripped Wall Street.
“When you have a real crisis, there tends to be a flight to quality,” said Ned Notzon, the chairman of the asset allocation committee at T. Rowe Price. “And the one sector that will do extremely well in such a market will be treasury bonds.”
©2009/The New York Times
Paul J. Lim is a senior editor atMoney magazine. Respond to this column at email@example.com