The Biased Investor (Part 8)
“Nothing ever changes, nothing ever will” – Les Miserables, Herber Kretzmer lyrics
“Fantine,” by Margaret Hall. Source: Wikimedia
Victor Hugo’s Les Miserable is a deeply enriching story of human suffering under various circumstances. It is considered one of the greatest novels of all time. It describes how one man moves from corruption and bestiality to grace and duty—from hell to heaven. Along the way, he interacts with characters moving the other way.
One refrain we hear in the musical version is that the impoverished and desperate circumstances don’t change very much, despite all the efforts of political and spiritual leaders. The revolt of the Paris Uprising of 1832 is violently put down.
It’s a very human tendency to believe that what we have seen lately is what we will continue to experience. We call this “recency bias,” along with “status-quo bias.” Investors look at the returns of the stock market for the past 50 years – 9.6% with dividends reinvested – and they assume that these returns can be repeated. But not all half-centuries are created equal. For the 50 years ending in 1980, US stocks returned less than 5%.
Returns from all asset classes—stocks, bonds, real estate, commodities—have been turbocharged since 1980 by falling interest rates. The price of any asset is the present value of all its future cash flows. If you decrease the discount rate—the interest rate used to determine the present value—the assets are worth more. Yields go down, asset values go up. In 1980 30-year US Treasury bonds yielded 11.3%. If you bought a long-term zero-coupon bond back then, your money grew over 30 times through 2010. But inflation was 12.5% in 1980. If that had continued, your money wouldn’t have grown at all, in real terms. inflation has fallen dramatically though, goosing returns.
30-year stock market total return: US, Japan, Inflation. Source: Bloomberg
Markets aren’t magic. They don’t provide excess returns just by sprinkling the pixie dust called risk over our savings so that we can retire comfortably. Returns come from economic growth. Just look at Japan. While the US was providing 7.6% real annualize returns over the past decade, the Japanese stock market has only eked out 0.4% returns. But it sure didn’t start out that way. We were all “turning Japanese” back in 1990.
Our limited perspective makes it seem like things never change. And to be honest, we don’t want them to change. Change can be threatening. But circumstances are always evolving, adapting to new techniques and technology. Human nature doesn’t change. But as markets adjust, we need to adjust our expectations.
Douglas R. Tengdin, CFA
Chief Investment Officer