When the person with arguably the greatest influence over the economy in the world opines that stock valuations are “quite high,” as Federal Reserve Board Chair Janet Yellen told an IMF conference last month, should investors take heed?
The answer quite simply is “No,” according to advisor and investment analyst Eric Nelson, whose latest post warns that we’ve seen this show before and already know it ends badly.
The Servo Wealth Management principal is referring to former Fed Chairman Alan Greenspan’s famous testimony about the stock market’s “irrational exuberance” in December 1996.
However high valuations were at the time, or whatever “potential dangers” (another Yellen comment last month) may have existed, the stock market more than doubled in the nearly three and a half years between Greenspan’s comment and the ultimate market crash in March 2000.
Investors who restructured their portfolios based on the revered Fed chief’s forecast would have achieved significant losses. How severe was the penalty for market timing, and how great the reward for steadfastness?
In his usual thoroughgoing fashion, Nelson quantifies the cost of acting on the Fed chair’s tip by viewing stock returns through three time perspectives: from January 1997 to March 2000, the period between Greenspan’s comment and the dot-com bust; from the same start time through the ensuing bear market’s conclusion in September 2002; and from the same start time until the end of the end of this May.
In that first three-and-a-half year period, the S&P 500 climbed just shy of 26% on an annualized basis.
That not only trounced the Greenspan comment’s implied investment alternative, cash, which delivered a 2.3% annualized return (using 1-month T-bills as a proxy), but it also beat Nelson’s preferred small- and value-tilted U.S stock portfolio (16.9%) and even more preferred small- and value-tilted global stock portfolio (13.3%).
Broadening the perspective to include the period of the subsequent crash that Greenspan’s remarks anticipated, we see that the S&P 500 did indeed suffer during that six-year stretch, delivering an annual average performance of 3%, which is indeed less than the 4.5% average annual performance of T-bills in that period.
But the small- and value-tilted global stock portfolio matched exactly the return of T-bills, whereas the small- and value-tilted U.S. stock portfolio handily beat cash, delivering a 6.3% annual average return.
Elongating the perspective to bring us to the end of last week, we can see that the large-growth oriented S&P 500 delivered a respectable if slightly depressed 7.7% annual return — certainly way ahead of the cash investor saw just 2.3% nominal return on his money these 18 years.
But investors in small- and value-tilted U.S. and global portfolios saw average annual returns of 9.9% and 9.4%, respectively — way ahead of the S&P 500.