A comprehensive look at the stock market's historical returns

I recently read Jeremy Siegel’s book Stocks for the Long Run. The book does a good job at looking at long term historical data for the stock market, and what investors in the stock market can expect. Nothing particularly new, but the data is comprehensive.
The main message I gathered from it is a humbling one:

Beating buy and hold is harder than you think. Just because a strategy beat buy and hold in the past, doesn’t mean that it will beat buy and hold in the future.
This is a truism that no trading guru will tell you. Gurus and trading “experts” are basically marketers. A marketer’s main job is to tell you “using my strategy/market outlook, you too can make a fortune in the markets!” A humble trader and investor always knows that what worked well in the past might not outperform in the future.

Here are some main points from the book and my accompanying notes.


The book begins with a quick look at the data.
Here’s the non-inflation adjusted return for various asset classes.

Here’s the inflation-adjusted return for various asset classes. No surprise here. Stocks outperform in the long run.

The stock market’s returns have been remarkably consistent over time. After adjusting for inflation, the stock market’s post-WWII return was 6.4% per year, which is the same as the stock market’s returns in the 125 years pre-WWII.
Here’s the interesting thing. This is a point that Warren Buffett mentioned in the past:

  1. Stocks are riskier in the short run but safer in the long run (i.e. 20+ years). In fact, no other asset class (bonds, commodities) has long term returns that are as stable as equities.
  2. Bonds are safer in the short run but more dangerous in the long run.

How can this be?

  1. Stocks have mean reversion
  2. Bonds have mean aversion

Stocks tend to mean revert. When they fall “too much”, they tend to go back up. This is because the stock market represents the economy, and in the long run, humanity progresses (even though there are long periods of short term pain).
Bonds are different. The more bonds deviate from the mean, the more they are likely to deviate even more from the mean in the future. This is due to a concept in economics called cost-push inflation. In essence, cost-push inflation causes inflation to spiral out of control. Think the Weimar Republic, Zimbabwe, or Venezuela. Spiraling out-of-control inflation kills bonds.

  1. The standard deviation of stock returns is higher than bond returns over periods of less than 15 years.
  2. But for holding periods greater than 15 years, stocks become less risky than bonds.
  3. Over 30 years, the standard deviation of stock returns is 25% the standard deviation of bond returns.

Don’t listen to your favorite gurus
The book does a good job at explaining why you shouldn’t listen to your favorite investing/trading gurus. No matter how smart someone sounds, how rich someone is, or how successful someone is – their market opinion is not much better than a 50/50 bet. Some of their market calls will be right. Some will be wrong. On balance, not a whole lot better than 50/50. Almost no one beats the market in the long run. Yes, some people get lucky. But trying to replicate someone else’s luck is like wishing you were born into a billionaire family.
History is filled with a long list of gurus with spectacularly failed market calls. These were the George Soros, Ray Dalio’s, and Robert Shiller’s of their era.

  1. Irving Fisher said in 1929 that “stocks had reached a permanently high plateau”. (Of course, stocks collapsed after 1929). Irving Fisher was ridiculously popular in his day – the modern day equivalent of Robert Shiller.
  2. In late-1995, Michael Metz (Oppenheimer), Charles Clough (Merill Lynch), David Shulman and Byron Wien (Morgan Stanley) turned bearish on the bull market. (Of course, stocks soared for another 4 more years). Each of these were executives at their respective financial firms. Smart, successful, yet all dead wrong.
  3. Roger Lowenstein said that stocks were “too overvalued” in 1996. Dead wrong. (Roger Lowenstein was a well-known author. Think When Genius Failed).
  4. Robert Shiller and John Campbell said that stocks were ridiculously overvalued in December 1996. They even presented their paper to the Federal Reserve.
  5. Floyd Norris also said that stocks were “too overvalued” in January 1997. Floyd was the lead financial writer for the New York Times. So the next time your favorite TV anchor on CNBC gives you investment advice, please think twice. As smart or professional as he is, he’s just as clueless as you are.
  6. In September 2002, famed bond fund manager Bill Gross said that “stocks should keep falling”. Of course, that was the bottom of the bear market.

Be careful when calling something a “bubble”
Far more failed market calls have been made trying to call a top than trying to call a bottom. Why?
It’s just very hard to know when a bull market will end. Calling a bottom is much easier than calling a top. You are going to be right more often when calling a bottom than a top.
Things that worked in the past will fail in the future. Here’s an example with valuations. This is Tobin’s Q, a popular valuation indicator.

From 1900 – 1995, Tobin’s Q usually peaked at 1. If you sold when Tobin’s Q approached 1, you would have avoided many massive bear markets.
Then in 1995, Tobin’s Q again approaches 1. You sell because “stocks are overvalued”. The bull market doesn’t top. It soars another 5 years. Even after the next bear market, the stock market is much higher than where it was when you sold.
What changed?
Valuations are tied to interest rates. Interest rates post-1990s were much lower than interest rates pre-1990s. Hence, average valuations post-1990s are higher than average valuations pre-1990s.
Average valuations in the future may stay consistently higher than average valuations in the past because:

  1. Investing has become much more popular since the 1980s. Before the 1980s, most households didn’t invest in stocks. (The introduction of the 401k played a role).  Hence, the overall demand for stocks is higher than in previous decades.
  2. Investing in stocks is cheaper than before becaues commissions have decreased dramatically and bid-ask spreads have narrowed.
  3. Interest rates are lower.

This doesn’t mean that stocks won’t fall or that valuations won’t fall from time to time. It’s normal to expect -50% declines in the stock market in the future. However, average valuations will remain higher in the future than in the past, once you factor out all the bull markets and bear markets.
Here’s another example of things that stopped working.
From 1871 – 1956, the S&P 500’s dividend yield was consistently above the bond yield. Investors at the time thought that this was necessary because stocks were riskier than bonds. This made sense in an era when stocks released most of their earnings as dividends instead of retained earnings. When most of a stock’s earnings = dividends, these dividends must > bond yields. Otherwise investors have no reason to hold stocks, which are riskier than bonds in the short run.
So whenever the S&P’s dividend yield fell below Treasury yields (because stock prices increased “too much”), that marked the start of major declines in the stock market. Similar to how Tobin Q readings that exceeded 1 preceded major declines in the stock market.
The strategy of selling stocks when the dividend yield fell below bond yields worked as a timing indicator for 80+ years.

Then came 1957.
Dividend yields fell below bond yields. Many investors sold, only to watch the stock market soar for another decade.
What happened?
There was a fundamental, permanent shift in interest rates and dividend yields.

  1. After the U.S. left the gold standard during the 1930s, chronic inflation began to affect interest rates. This made nominal interest rates higher than they used to be.
  2. Companies decreased their dividend yields after WWII and retained more of their earnings. Hence, capital gains accounted for more of investors’ returns and dividend yields accounted for less of investors’ returns.

Moral of the story: things that worked in the past will stop working in the future, and you have no idea when it will stop working until it has already stopped working for a long time. Moreover, you need to truly understand fundamentals before you use them. Don’t use surface-level fundamental relationships. Surface-level fundamentals that worked perfectly in the past will break down in the future if you don’t understand why they worked in the first place. If the underlying reasons changed, then the fundamental relationship will break as well.
Another common fear in recent years is the increase in corporate profit margins. Many (including GMO founder Jeremy Grantham) have said that these margins are unsustainable and that if margins contract, then that will lead to falling corporate earnings and falling stock prices.

Jeremy Siegel explains that this fear is unfounded. There is a good reason why corporate profit margins are trending higher over the decades.

  1. U.S. corporations have less leverage than in past decades. This reduces interest expenses and boosts profit margins.
  2. 1/3 of the increase in profit margins from 1990 – present is due to the increased share of profits from foreign countries. Foreign nations tend to have lower corporate tax rates than the U.S.
  3. The other increase in profit margin is primarily due to the increase in tech stocks. Tech companies have much higher profit margins due to the nature of their business.

In other words, profit margins don’t stay static over time because the world changes.
The 2007-2009 crisis
Jeremy Siegel presents a lot of interesting facts about the 2007-2009 crisis.
For starters, the Fed let Lehman fail and bailed out many other banks for political reasons. Earlier in 2008, the Fed bailed out Bear Stearns, Fannie Mae, and Freddie Mac. This caused a lot of political criticism. After the March 2008 bailout of Bear Stearns, the Bush administration said “no more bailouts”, which meant that they had to let Lehman fail. But when the whole financial system crashed after Lehman failed, the government had no choice but to bailout the other banks.
Finance professionals and amateurs love to criticize the Federal Reserve for its bailouts and successive rounds of QE. In Jeremy Siegel’s opinion (which I also share), the Fed did the right thing.
2008 was marked by deflation. Deflation worsens a recession.

  1. When prices are falling, consumers might think “I’ll just wait a few months to buy when things are even cheaper”. This belief can become self-fulfilling and self-reinforcing. Their abstinance causes demand to fall, which causes prices to fall even more. Prices become stuck in a downwards loop.
  2. When prices fall, wages fall. This increases the burden of debt when adjusting for inflation. Imagine you owe $1 million, and you made $100,000 last year. Now, you owe $1 million and only make $80,000. Your debt burden just increased significantly.

This is why the Fed focused so much on inflation targeting post-GFC. Deflation is deadly, and can cause a nation to be stuck for 20 years like Japan post-1990.
Through its actions, the Fed prevented 2008 from turning into a Great Depression scenario. In the Great Depression, M2 (money supply) fell by almost 1/3. In 2008, money supply increased as the Fed injected liquidity. This meant that banks were not forced to call in loans in 2008 as they were in the 1930s. (Banks calling in loans was part of the death-spiral that caused the Great Depression).
Contrary to popular belief at the time, the Fed’s QE did not lead to skyrocketing inflation. Why?
According to The Monetary History of the United States, it’s the quantity of deposits + currency (M2) that’s most closely related to inflation. Not the monetary base (includes reserves). QE caused the U.S.’ monetary base to triple from 2007-2013, but all of this was due to an increase in reserves that banks did not lend out. In other words, M2 did not increase significantly.
In layman’s terms, the newly printed money was not loaned out to the average Joe, so no hyperinflation.
Problem with the S&P 500’s operating earnings vs. NIPA
When trying to understand the stock market’s “earnings” (which is important when creating a P/E ratio for the stock market), traders commonly quote the S&P 500’s “operating earnings”.
This is problematic, because “operating earnings” (based on GAAP accounting rules) often underestimates true earnings for the stock market.
This is why the S&P’s “P/E ratio” soared in 2008 despite the stock market crash. The stock market tanked -50%, but “operating earnings” crashed 92%.

Instead of using the S&P 500’s operating earnings, use NIPA earnings.

  1. Operating earnings fell 92% in 2008
  2. NIPA earnings fell 24% from June 30, 2007 to March 31, 2009.

On the issue of diversification
Conventional financial wisdom states that investors should diversify their portfolio, which theoretically should increase risk-adjusted returns.
This argument is flawed primarily because global stock markets are heavily correlated nowadays.
The following chart demonstrates that U.S. stock market’s 5 year rolling correlation with various asset classes such as emerging markets (Em Mkt) and other developed economies’ stock markets (EAFE).

As you can see, correlations have increased massively from 2000-present.
So the next time your financial advisor or trading guru tells you to “sell U.S. stocks, buy emerging markets”, realize that it’s impossible for foreign stock markets to soar while the U.S. stock market crashes.
The increase in correlation is obvious.

  1. Economies around the world are more interdependent than ever before. This interdependence will only increase.
  2. Capital is more mobile and now operates on a global scale. The same big traders and investors are now operating in many countries around the world. So when a massive investor needs to liquidiate his positions, he will sell his U.S. stocks, Japanese stocks, and German stocks simultaneously.

The power of $25 million
Did you know that $25 million (in today’s dollars) invested in 1802 would equal to $18 trillion today? How is this possible? The stock market is only $25 trillion today, but it was far greater than $25 million 1802.
In other words, how could someone who owned e.g. 5% of the U.S. stock market in 1802 end up with almost 75% of the U.S. stock market today?
Because of dividends reinvested.

Dividends account for a massive part of an investors’ returns. The stock market is constantly throwing off these dividends to investors. Someone who buys and holds would reinvest these dividends back into the stock market, instead of spending these dividends like most investors do. Hence, an investor who reinvests his dividends would increase his share of the stock market ownership from 5% to 75% over 200+ years.
*Obviously, no one lives 200+ years. But this illustrates the point that dividends are an important source of returns, especially pre-WWII.
Gold standard and inflation
The gold standard was abandoned in the 1930s because it worsens economic crisis. (Strict adherence to the gold standard worsened the 1929-1932 stock market crash and economic recession).
One of the side effects of abandoning the gold standard was chronic inflation. Chronic inflation was non-existent pre-1930s.

There are only 3 assets you need to hedge against all macro environments.

  1. Gold (good for high inflation periods)
  2. Short term government bonds (good for economic recessions)
  3. Stocks (good for economic expansions)

*Reserve currencies tend to do well during financial crises. Gold surged during the 1929-1932 stock market crash not because it was a “hedge against inflation”, but because gold was essentially the reserve currency of its time. During financial crises, everyone flocks to reserve currencies. “Cash is king”. After the gold standard was broken, the USD became the world’s reserve currency. This is why the USD surged in late-2008.

  1. Pre-Bretton Woods, gold was a hedge against surging inflation & financial crises.
  2. Post-Bretton Woods, gold is only a hedge against surging inflation.

An interesting answer to an interesting question.
I have always wondered this before:
Over the past 200 years, the stock market yields an average of 6-7% per year (inflation-adjusted). Meanwhile, the U.S. economy grows at an average of 3-3.5% per year (inflation-adjusted). How is this possible? If the stock market keeps growing faster than the U.S. economy, eventually, the U.S. stock market will be bigger than the U.S. economy!
There are 2 factors to answer this question
Factor #1: The U.S. stock market derives more and more of its earnings from other countries. I.e. the U.S. economy is the main, but no longer the only source driving U.S. stocks.
Factor #2 (this is much more important than Factor #1): the U.S. stock market only yields an average of 6-7% per year when you include dividends reinvested. Look back at this chart.

Most investors don’t reinvest their dividends. Instead, they use their dividends as income for expenditure. Hence, the size of the stock market does not grow significantly faster than the size of the economy over time. The stock market is constantly “shedding” and shrinking itself by issuing dividends to investors.
Beware of popular trendlines
A lot of market gurus use trendlines and channels to describe how “overstretched” or “cheap” the market is.
These trendlines are flawed because they either fail to take into account inflation or dividends. The following chart takes into account inflation, but fails to take into account dividends.

Here we can see a simple problem. Based on this chart, the S&P practically went nowhere from 1880-1950. But that was merely because during those 70 years, most of the stock market’s gains were thrown off as dividends. Dividends accounted for the bulk of gains, whereas capital appreciation accounted for much less. But from 1980 – present, dividend yields have shrunk significantly while companies retain more of their earnings. Hence a correctly drawn trendline in this chart would flatten the trendline pre-1980 and steepen the trendline post-1980.
How the S&P changed over time
Everyone quotes “the S&P” or makes historical references to “the S&P”. But do you actually know what’s in the S&P? Do you know how the S&P has changed over time?

  1. The Standard & Poors Index began in 1923, and in 1926 it became the Standard & Poors Composite Index. This index contained 90 stocks.
  2. The Index expanded to include 500 stocks on March 4, 1957 and became the S&P 500.
  3. The original S&P 500 included 425 industrial stocks, 25 railroad stocks, and 50 utility stocks. Notice how some young industries were notably lacking (finance, tech). But despite the lack of diversity, this index encompassed 90% of the total U.S. stock market cap at the time. Today, the much more diversified S&P 500 only accounts for 75% of the U.S. total stock market cap.
  4. The S&P 500 adjusted its industry and stock weightings as the U.S. economy and U.S. industries evolved.

A very interesting way to beat “buy and hold” for the S&P 500
The S&P 500 is a large cap index. As a result, the index constantly reshuffles itself, selling stocks that are falling and buying stocks that are rising above a certain threshold.
But if you buy and hold the original 500 stocks in the S&P 500 from 1957 – present (no reshuffling), you would earn more than 11.1% a year: 1% higher than the S&P 500 itself.
How can this be? How can buying and holding a bunch of stodgy old companies outperforming reshuffling one’s portfolio to account for all the new companies (e.g. Google, Apple, Amazon)?
It’s the idea behind “size” investing. (Remember how we mentioned that as per the “size” factor, small cap stocks outperform large cap stocks.)
The S&P includes stocks once a stock’s market cap reaches a certain level. The S&P discards stocks once a stock’s market cap falls below a certain level. Due to the threshold, the S&P 500 constantly adds stocks after the stock rises a lot. This is a drag on future performance, especially if the stocks that were added subsequently collapse.
The book illustrates several notable cases.

  1. In the energy crises of the early 1980s, the S&P added Global Marine and Western Co to the energy sector, which subsequently went bankrupt. In other words, the S&P 500 bought high, and sold low
  2. The S&P 500 added almost 40 new tech firms in 1999 and 2000. Examples include WorldCom, Global Crossing, and Quest Communication. When the tech bubble burst, these stocks were a big drag on the S&P 500. Once again, the S&P 500 bought high, and sold low

So yes, an investor who just bought and held the original 500 stocks would not have experienced fantastic gains from new and innovative companies like Google, Amazon, Apple, etc. Yes, many of the stocks in the original 500 companies would have gone bankrupt over the past 60+ years. But at the same time, he would not have been dragged down by all the massive duds over the years that the constantly reshuffled S&P index faces. These duds outweigh the benefits from new companies & avoiding failed old ones.
This is why Warren Buffett says “my favorite holding time frame is forever”. (Warren Buffett does sell stocks from time to time, but infrequently). Someone who buys a diversified portfolio of stocks and never sells actually beats someone who buys and holds a S&P 500 index ETF. 
Buying and holding the S&P 500 index isn’t true “buying and holding”, because the index has its own stock picking strategy in a sense. The index’s stock picking strategy is “buy high, and sell low”. This works great for companies that really take off (e.g. Google, Southwest Airlines, Apple). But it’s terrible for companies that are fly-by-night duds.
*This strategy only works if you already have a sizeable portfolio, e.g. $1 million. Without a sizable portfolio, you will not have enough diversification to essentially replicate the S&P 500
*If you don’t want to buy 500 stocks, you can essentially replicate this strategy by only buying small cap stocks. If the S&P 500 index is constantly being hurt by “buying high and selling low”, then an index that does the opposite (e.g. S&P 600 – a small cap index) would benefit by constantly “buying low and selling high”.
*Alternatively, you can buy and hold a total market index fund such as the Vanguard Total U.S. Stock Market Shares Index. These ETFs are the real “buy and hold”. By buying every single stock, these ETFs never sell and get hurt by the “buy high, sell low” rule that the S&P 500 uses.
The book presents 2 interesting charts on U.S. tax rates over the ages.

It’s clear that the government has always treated capital gains more favorably than income. This is because the government supports entrepreneurs, who are the drivers behind long term economic growth.
It’s also worth noting how high income taxes were from the Great Depression until the Ronald Reagan era. A lot of people complain about “increasing economc inequality”. It’s clear why economic inequality expanded dramatically after the 1970s. Income taxes fell. Paying your executives $2 million a year in the 1970s didn’t make a lot of sense if they were going to be taxed at 80%. A socialist economy always has less economic inequality because the tax system deems it so.
The problem with factors and smart beta
“Factor” investing is based on the idea that one can outperform “buy and hold the S&P 500” if you tilt your portfolio in favor of certain factors:

  1. Size: small cap stocks tend to outperform large cap stocks as a group
  2. Value: value stocks tend to outperform growth stocks as a group. Value stocks typically occur in industries with low expectations of future growth or are heavily tied to the business cycle (e.g. oil, cars, finance, utilities). (“Value” and “cyclical” are often used interchangeably).
  3. Momentum: stocks that are outperforming tend to keep outperforming in the short term.

Jeremy Siegel demonstrates that these factors are not consistent. Here is the size factor.

As you can see in the above chart, small cap stocks yielded an average of 11.52% a year while the S&P 500 (large cap stocks) yielded an average of 9.69% a year. But this outperformance entirely came from the 1975-1983 period. Excluding this period, large cap and small cap stocks would have had the same performance.
From 1975-1983, large cap stocks earned 15.7% a year while small cap stocks earned 35.3% a year. What caused the sudden outperformance:

  1. From 1975 – 1983, institutional managers were attracted to smaller stocks after the collapse of big Nifty Fifty stocks in 1973-1974.
  2. The Employee Retirement Income Security Act of Congress in 1974 made it easier for pension funds to buy small stocks. Their buying helped small cap outperform.

Large vs. small outperformance/underperformance tends to go in cycles.

  1. Large cap outperformed in the 1970-1972 bull market (Nifty Fifty
  2. Small cap outperformed from 1975-1983.
  3. Large cap outperformed from 1983-2000 (especially in the late-1990s, when tech stocks soared).
  4. Small cap outperformed from 2000-2007 (especially during the 2000-2002 bear market, when large cap tech stocks were clobbered).
  5. Large cap outperformed in the 2009-present bull market (big tech companies once again outperforming).

Herein lies the key point. So many investors are aware of factor investing and smart beta. It makes you wonder whether these factors will continue to outperform in the future. In the market, things that worked in the past tend to stop working once they are widely disseminated.
You can imagine a world in which small cap stocks underperform large cap stocks permanently.
Small cap, value stocks tend to outperform in bear markets (although this didn’t apply in 2007-2009) and at odd times (e.g. 1975-1983).
But what if in the future, large cap stocks outperform because they are more exposed to the international economy? I.e. large cap stocks have more benefits to growth because they tap markets outside of the U.S.
In a way, this makes you wonder if using our fundamental models will work better for small cap indices than large cap indices. Small cap stocks are more impacted by the U.S. economy than large cap stocks because small cap companies derive more of their corporate earnings from the U.S. than large cap companies. Hence, it makes more sense to apply fundamental data when trading small cap indices. 
Going forward, we shall apply our trading models to the NASDAQ, Russell 2000, and the S&P 600 (a better small cap index than the Russell 2000).
Dogs of the Dow
A well-known strategy for beating the market is to buy the “Dogs of the Dow” (aka Dow 10). The strategy buys and holds the 10 Dow Jones stocks with the highest dividend yields each year. The strategy recalibrates once a year, at the start of the year. In a way, this is like buying “value stocks” (Stocks with the highest dividend yields tend to have high dividend yields because their stock prices have fallen significantly). This is tilting in favor of the “value” factor.
A similar strategy is to buy the 10 stocks with the highest dividend yields out of the 100 largest (by market cap) S&P 500 stocks each year.
The outperformance of this strategy is striking.

But once again, this strategy has lagged in recent years (a lot of the outperformance occurs in bear markets. Cheap stocks fall less than expensive stocks during bear markets). Once again, this illustrates the problem that the more a successful strategy is known, the less it tends to work.
Forget about “recessions”
You can’t use the government’s definition of a “recession” to make market timing decisions.
It’s commonly believed that a “recessions” occurs when real GDP falls for 2 consecutive quarters. This is not true.
An official “recession” is declared by the NBER. The NBER does not use a single rule/measure to define “recessions”. Instead, it looks at employment, industrial production, real personal income, and real manufacturing/trade to determine economic recessions. The NBER uses discretionary judgement to call a “recession”.
Before calling a “recession”, the NBER always waits until there is not a shadow of a doubt that the economy is in a recession. This is why “economic recessions” are lagging indicators for the stock market.
The NBER often waits a long time before calling a recession, until the recession is already well under way. For example, the NBER in December 2008 said that “the recession started in December 2007” – 1 year after the recession had started. The 1990-1991 recession ended in March 1991, but the NBER did not state “the recession ended in March 1991” until December 1992.
Clearly, you must use macro economic data on your own to determine the state of the economy. Relying on the NBER is too late.
Also, don’t listen to the economists and their predictions. Their predictions are often no better than a coin toss. For example, most of the top U.S. economists in September 1974 did not think that the U.S. was in a recession when in reality, the U.S. was in an extremely painful recession.
Wartime stock markets are different from peacetime stock markets.
Do you know why the stock market went nowhere in WWII? If corporate profits and the stock market move in the same direction in the long term, why didn’t stocks rise in WWII? Afterall, factories were pumping out massive volumes of supplies, ammunitions, etc.
FDR didn’t want corporations to earn easy profits as they did in WWI. These profits generated a lot of public criticism (the public was angry that young men were dying overseas while corporations were reaping record profits at home). Congress passed an excess profits tax, thereby forcing companies to earn less money.
On the issue of fund managers and trading gurus

  1. It’s very hard for you to know if a fund manager/trading guru is successful right now because of luck or skill.
  2. It’s very hard for you to know if a fund manager/trading guru is underperforming right now because of luck or [lack of] skill.

According to the author, it would take someone 15 years before they could be statistically certain that a manager/guru is performing well because of skill or performing poorly because of skill.
This is why the finance industry is full of so many charlatans – fund managers and trading gurus who sell you the dream after outperforming for only a few years.

  1. Guru XYZ outperforms for 5 years, and sells you a trading course so that “you too can outperform, just like him” (when in reality, the guru was just lucky).
  2. Guru XYZ underperforms for 5 years, and tells his customers “losing from time to time is just a normal part of the outperforming process” (when in reality, the guru can’t outperform at all).

By the time you discover that your favorite guru/investment fund manager is nothing more than a smart-sounding marketer, it’s too late. 15 years have gone by.
*15 years is based on being accurate at least 95% of the time


Jeremy Siegel’s book offers a lot of interesting insights into the market. Investors often approach the market with a concept, without actually doing deep research. (E.g. many investors will “buy the S&P”, without even really knowing what is in the S&P).

  1. Strategies that outperformed in the past often lose their edge once a lot of people use them.
  2. The optimal combination for a buy and hold portfolio is small cap (size factor), value stocks (value factor), and don’t let your index reshuffle (the S&P’s reshuffling is the opposite of “small” and “value”).

*If you can use leverage like Warren Buffett on low volatility stocks, your performance would improve even more.
“Small” and “value” sound enticing.

  1. Small cap stocks don’t have the S&P 500’s reshuffling problem. Small cap stocks are also more responsive to U.S. economic data because small cap stocks tend to be domestic stocks.
  2. Value cap stocks don’t have the S&P’s reshuffling problem. Value stocks are also more responsive to U.S. economic data because value stocks tend to be cyclical stocks.

But I have 2 worries:

  1. Will small cap stocks undperform large cap stocks in the future? Nowadays, more and more of the best small cap companies are choosing to stay private until they turn into large cap companies (e.g. Uber, Airbnb)
  2. Value stocks are good for Americans, but not good for foreigners. Value stocks tend to have higher dividends. Foreign investors are hurt via withholding taxes on dividends.

9 comments add yours

  1. If out of control surging inflation hit the USA, how would we protect our savings.

    • If you’re worried about out of control inflation, then gold is your best bet

  2. Wow, Troy.
    Thank you for this amazing report. Insightful and accurate.
    look forward to see your models applied to Nasdaq and other indexes.

  3. Great info Troy, I would ad that small cap will underperform when the fed is raising short term rates as will companies with lots of debt like Netflix, Tesla or AT&T. Also small cap is usually a great leading indicator to determine the direction of the S&P500. We just witnessed this with the Russell 2000 struggling to break the 200 day SMA and once it broke down the S&P soon followed. I love the idea of using the top 10 dividend utilizing DRIP to increase shares and buying value or perceived value but it flies in the face of pure momentum. I ran the indexes through stockcharts and was pleasantly surprised by the results. Very good stuff and continue to look forward to what’s next. I must say the best decision I’ve made was investing In Bullmarkets, Thank you!

    • I find it interesting how both “value” and “momentum” outperform. Value and momentum tend to be opposites.
      I think it comes down to this:
      Value —– Average S&P stocks —– Momentum
      Stocks that are in the middle (exhibit neither value nor momentum) have average performance
      Stocks on both extremes outperform

  4. Hi Troy, I was a big buyer in December Of the S&P & sold February 22nd & thought after a short pull back we would be flying again. I thinking now with what I am seeing, maybe after a brief rally near the September high but not above it, will be all stocks have for 2019.
    Ever since you mentioned the 1957 stock market pullback, I have had an eye on it ,& I see similarities.
    Are you looking at it as a high probability 1957 type of market.
    Thanks, Ray

    • Hi Ray,
      Right now, I think neither bulls nor bears have an edge over the next month. Hard to say

  5. Hi Troy,
    I believe the S&P600 small cap index will be affected similarly by reshuffling, as it contains both stocks below it and stocks above it. This means it WILL be exposed to a reshuffle as stocks fall off the bottom but also as stocks gain momentum and blast off the top.
    You could argue that these two opposing forces will balance out whereas the S&P500 only allows stocks to fall off the bottom… however S&P500 also holds its winners (the ones that don’t fall off the bottom that is), just like Buffet, so is thereby exposed to LESS reshuffling.

    • I think the S&P 600 constantly reshuffles, whereas the Russell tells everyone in advance “we will reshuffle on XYZ” date. Hence, this it is easier to frontrun the Russell than S&P 600. I could be wrong, but I have seen others say (in more or less colorful language) “don’t ever use the Russell, the RUT indices are trash”

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