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John Engle
John Engle
Articles (610) 

The Danger of Assuming Stocks Always Go Up

The experience of stock exchanges around the world offers a bitter lesson for US investors

February 25, 2021 | About:

There is a view widely shared among investors that, over the long run, stocks always make a good investment, even if you buy at sky-high prices. This belief has only intensified over the past decade as investors and allocators have increasingly favored passive investing strategies.

However, the varied experiences of stock markets around the world suggest that such faith in the long-term upward trajectory of stocks may be misplaced.

Always up and to the right

The notion that "it's about time in the markets, not timing the markets" is hardly a novel one. The inexorable rise of passive investing and low-cost index funds has helped instill the view so deeply that it has become something of an article of faith for many investors and expert analysts. Invesco's Kristina Hooper, for example, expressed it quite clearly on Feb. 8:

"We don't know if we are in a sustained rally or a speculative bubble until it is in the rear-view mirror — and it really doesn't matter for longer-term investors. The reality is that market rallies and corrections occur (even Minsky moments will happen), but the trend line for stocks over the long run is upward."

Faith in the long-term upward trajectory in aggregate is not limited to passive investors, however. Indeed, even Warren Buffett (Trades, Portfolio), whose Berkshire Hathaway (NYSE:BRK.A)(NYSE:BRK.B) is famous for buying attractive companies when markets get choppy, has expressed the sentiment from time to time, such as in 2018 when he claimed, "I don't know when to buy stocks, but I know whether to buy stocks."

Inevitability not guaranteed

The idea that stocks will always go up has some historical merit. The experience of the U.S. stock market over the past century certainly demonstrates that an enduring pattern of long-term directionality is possible. However, as Bloomberg pointed out on Oct. 31, this has not been the case for other stock markets around the world:

"Consider the FTSE 100, an index of some of Britain's preeminent pharmaceutical, energy, mining and consumer goods companies. In price terms (ignoring the impact of reinvesting dividends for a second), the U.K. benchmark is lower now than it was two decades ago. It's not alone. The Stoxx Europe 600 benchmark also remains beneath its dot-com-era peak while the MSCI emerging markets index topped out in 2007 and has yet to recover...The Nikkei 225 index remains about 40% below its 1989 peak, when a massive financial bubble burst."

Clearly, stock markets do not always go up. As the world's largest and most powerful economy, as well as playing host to the world's effective reserve currency, the U.S. has had many tailwinds supporting its capital markets in recent decades. If the relative importance of the U.S. economy were to decline, it could be the undoing of the long-established pattern in its capital markets.

My verdict

Investors' trust in the stock market's long-term growth has been rewarded handsomely over the past decade. With stocks continuing to test all-time highs despite growing economic and geopolitical uncertainty, maintaining such trust may not be wise. When reasonable trust turns into blind faith, investors are liable to get into trouble.

Ultimately, I consider investors' belief in the sustainability of the "uniquely American" capital markets experience to be unfounded. Many other markets have faltered, flattened, or fallen without later bouncing back. The U.S. still has many advantages going for it, but as they dwindle, the risks will intensify.

Disclosure: No positions.

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About the author:

John Engle
John Engle is president of Almington Capital Merchant Bankers and chief investment officer of the Cannabis Capital Group. John specializes in value and special situation strategies. He holds a bachelor's degree in economics from Trinity College Dublin, a diploma in finance from the London School of Economics and an MBA from the University of Oxford.

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