Is It Really That Hard To Beat the S&P 500 over time?

Since I started investing almost 20 years ago, the goal I had always read about was beating the S&P 500 over time.  Mutual funds were, a lot of times, compared to that benchmark for performance and it was amazing how it didn’t happen much at all.  When I read books about Graham/Dodd, Buffett’s mentors, they always stated they had the goal of making 2.5% better than the S&P 500, annualized, over time.  It may not sound like much, but if you do the math, if market gains 10% per year for 40 years and you are able to do 12.5% per year over 40 years, you are talking about 2.5 times more money! $1MM, after 40 years, would be $45MM @ 10% per year but $111MM at 12.5% per year and that assumes not adding anymore money.  So it’s quite considerable.  It makes it all the more impressive that Buffett has been able to achieve returns almost 10% more per year than the S&P 500 over a nearly 60 year career.

So how hard is it really?

I recently purchased a Bloomberg machine, which is a great machine that will allow me to pick different stock screeners and then backtest them as far back as 25 years in some cases.  It will then show me the per year returns vs the S&P 500 and it even allows me to select how often I rebalance.  So I decided to take a few swings to see how it would do by using some of the things I have learned in the past about equities that work over the long haul by many value investors….

What was the result?  If you stayed disciplined and followed the same rule, year after year, it actually was not hard at all to beat the S&P 500.  Yes, there were many years in which you didn’t beat the S&P, but over time, you easily beat the S&P and then some. And it didn’t take convoluted and complicated attributes to search for.  (More on that in another post).

So why do so many money managers fail to beat the S&P 500 year after year and over long periods of time?  Well, that’s when human nature comes into play. Money managers chase returns.  They’re almost forced to, which is sad, but it is the business they are in.  Granted, they tend to not do a great job explaining the reason for their investment decisions and they tend to be made because other managers and the market are doing well in certain areas, but the bottom line is, it proves that chasing returns is a sure way, in the long run, to lose.  When you finally get to the party, as has been proven time and time again, you will find that everyone has either left or are on their way out.

Side Note: I have found a very nice screener that over a 22 year period beat the market by over 4.5% per year.  Based on the # of stocks in that screener each year, I was VERY pleased to see the results and I will discuss, in more detail in another post, what I found with this screener.  Unfortunately, I won’t be offering the exact screener because then my work on the Bloomberg machine I paid for will be released and I’m too selfish to give away the things I have spent time looking for.  :-)

I’m Back

There has been a large gap between my most recent posts.  It’s been hard to keep writing the same thing over and over again, and to watch the market continue to go higher. I have not given in and bought into this market, though.  I am still going to keep that patience because the higher this goes without any substantial increase in fundamentals, the more I know that things will revert back and revert back in a strong way.

I recently purchased a Bloomberg machine which allows me to backtest stock strategies over the past 21 years.  That’s annoying, however, considering I would want to backtest going back 40-50 years, to see how my strategies would have faired during secular bull and bear markets.  Now…with that in mind, going back 21 years, the stock market total return has been about 9.5% per year which is actually lower than the 100+ year historical average of 9.9%.

Since September 18th, we have had a nice pull back on the S&P 500 and I love seeing the pundits on TV talking about how this is a great buying opportunity. Of course it is…if you want to ignore all fundamentals and historical valuation metrics that have proven to be accurate.  Market Cap to GDP ratio, which Warren Buffett describes as probably the single most accurate stock market valuation metric at any given time, is at levels that have only been rivaled by late 1999 and early 2000. Based on these metrics, the 10 year outlook on the S&P 500, including dividends, we are near 0% returns, annualized, per year for the next 10 years. That’s awful. Historically, the market should be making 10% per year, so to get to that kind of valuation, the market has to drop in half to get the expected 10% per year annualized return.  It sounds unreasonable?  Ok.  The same thing was said after the mid 1970s cyclical bull market.


The Story Hasn’t Changed

I haven’t posted in a while.  It’s been a frustrating year.  I was getting excited when the S&P started the year down 5%. I thought “This is it!”  And of course, I was wrong. I keep reading more and more people say that we are in the beginning parts of a new secular bull market.  I actually get upset when I read that.  It’s so unbelievably dangerous.  Secular markets start and end based on valuation.  We are at all-time historical highs in valuation.  Higher values than even 1999 and 1929, in many regards.  Secular bull markets have started, in the past, when the stock market to GDP ratio has been sub 50%, and right now we are at 130%!

Patience is a virtue and I lack it in every aspect of my life…except investing.  I’ve been blessed with that ability to be patient.  Has it been trying?  Of course.  But these cycles do take time.  As John Hussman said in his post tonight, and as a former partner of mine always says “Market tops aren’t just points…They are processes.  We are in the process, hopefully, of this.  I say “hopefully” because I have been wrong for quite some time. But I do feel good knowing that the longer I am wrong, the more likely the devastating result that will follow.  Thinking that another 50% drop (3rd in 15 years) is not likely is a fool’s wish.  History has shown that during times of immense overvaluation, prices fall, fundamentals don’t rise.

For those reading this who think I’m kooky, keep on thinking it.  It’s been hard thinking otherwise.  But again, please don’t say “it was so obvious” in a few years when the market has fallen 40%.  It’s just insulting.