Beware The Ides Of ???

¹²Beware The Ides Of March?
Some Are Drawing Wrong Lessons From This Week's Anniversaries

By Mark Hulbert, Marketwatch | 13 March 2010

ANNANDALE, Va. (MarketWatch)— This is a column about the investment lessons you should NOT be drawing this week. The occasion, of course, are the two anniversaries about which a lot of ink has already been spilled: The one-year birthday of the current bull market, and the 10-year anniversary of the Internet bubble bursting. Unfortunately, some of what investors are being told they should have learned from these two momentous events is neither particularly accurate nor very helpful.

Take, for example, the notion that there might be something special about March, which would make it a month that is particularly likely to see the beginning or ending of major market moves. I can understand why some might think the month does have this quality. Can it be a mere coincidence that the bursting of the Internet bubble 10 years ago began on March 10, and the beginning of one of the most powerful bull-market rallies in history began a year ago on March 9.

Well, yes.

Consider all the bull and bear markets since 1900, according to the exacting definitions employed by Ned Davis Research, the quantitative research firm. Even taking into account the bursting of the Internet bubble in March 2000 and the beginning of the current bull market a year ago, the month of March historically has nevertheless seen a below average number of bull or bear markets beginning or ending. (There are two months that are tied for having the greatest number of these major market turning points, by the way: September and November. Investors should therefore be saying: "Beware the ides of September and November.")

This misplaced belief about March being a turning point about the market is not the only investment lesson that should not be drawn from this week's anniversaries. Another is that the last decade shows us that we can no longer count on the stock market to provide a decent long-term return. A belief that stocks do provide that decent long-term return is the bedrock assumption of most financial plans in this country, so it would be very unsettling for investors to discover that their financial plans are built on such a faulty foundation.

The commentators drawing this ominous lesson appear to have a strong case in the 10-year performance of the Nasdaq Composite Index (COMP) . That index closed at 5,048.60 on March 10, 2000, versus 2,332.21 today— for a 10-year drop of 53.8%. To put this into perspective, consider that this index would have to gain 116% from current levels just to make it back to where it stood a decade ago. And it has this deep a hole to dig itself out of, even though it has already gained 84% in the last 12 months alone.

So much for index funds reliably providing long-term profits that are consistently superior to those of other asset classes. Devastating as this is, however, I don't think the Nasdaq Composite's performance should be used to call the stock market's long-term prospects into question. The historical record on which researchers base their long-term confidence in equities is derived from a broad-based index, such as the S&P 500 index (SPX). [[Or, the Wilshire 5000.: normxxx]] In contrast, the Nasdaq Composite is not well diversified at all.

This was even more the case 10 years ago than it is today, in fact. Then the index then was an incredibly concentrated bet on just a few Internet companies. The Nasdaq Composite is a so-called cap-weighted index, after all, so a stock's weight in the index is a function of its total market cap. And 10 years ago, Cisco Systems Inc. (CSCO) was the largest stock in the index, dwarfing the market caps of the vast majority of the thousands of other Nasdaq-listed issues. I need not remind you that Cisco today is some 70% below its level of 10 years ago.

The proper investment lesson to learn from the Nasdaq's struggles, in my opinion, has to do with the virtues of diversification. Your chances of recovering relatively quickly from a bear market are markedly lower to the extent you have been under-diversified. Contrast the experience of the Nasdaq Composite with that of the Wilshire 5000 index, which is the broadest index possible, reflecting the combined performance of all publicly traded stocks. Over the last decade, when you include dividends, the Wilshire 5000 index has shed just 1.1%— 0.1% per year on an annualized basis.

That's nothing to cheer about, to be sure. But it is not unprecedented in the history of the U.S. stock market, and a whole lot better than being down 54%, as the Nasdaq Composite index is. Education, a wise man once said, is never expensive once attained. Perhaps, if we all truly learn the benefits of diversification because of it, the bursting of the Internet bubble, and the big losses to which it led, will not have been in vain.

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Normxxx    
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