We are convinced that the average investor cannot deal successfully with price movements by endeavoring to forecast them. Can he benefit from them after they have taken place—i.e., by buying after each major decline and selling out after each major advance?
The fluctuations of the market over a period of many years prior to 1950 lent considerable encouragement to that idea.
- In fact, a classic definition of a “shrewd investor” was “one who bought in a bear market when everyone else was selling, and sold out in a bull market when everyone else was buying.”
- If we examine the fluctuations of the Standard & Poor’s composite index between 1900 and 1970, we can readily see why this viewpoint appeared valid until fairly recent years.
Between 1897 and 1949 there were ten complete market cycles, running from bear-market low to bull-market high and back to bear-market low.
- Six of these took no longer than four years, four ran for six or seven years, and one—the famous “new-era” cycle of 1921–1932—lasted eleven years.
- The percentage of advance from the lows to highs ranged from 44% to 500%, with most between about 50% and 100%.
- The percentage of subsequent declines ranged from 24% to 89%, with most found between 40% and 50%. (It should be remembered that a decline of 50% fully offsets a preceding advance of 100%.)
- (1) a historically high price level,
- (2) high price/earnings ratios,
- (3) low dividend yields as against bond yields,
- (4) much speculation on margin, and
- (5) many offerings of new common-stock issues of poor quality.
- to identify the recurrent bear and bull markets,
- to buy in the former and sell in the latter, and
- to do so for the most part at reasonably short intervals of time.
- value factors or
- percentage movements of prices or
- The most notable of these departures, of course, was the great bull market of the late 1920s, which threw all calculations badly out of gear.*
- Even in 1949, therefore, it was by no means a certainty that the investor could base his financial policies and procedures mainly on the endeavor to buy at low levels in bear markets and to sell out at high levels in bull markets.
- The market’s behavior in the past 20 years has not followed the former pattern, nor obeyed what once were well-established danger signals, nor permitted its successful exploitation by applying old rules for buying low and selling high.
- Whether the old, fairly regular bull-and-bear-market pattern will eventually return we do not know.
- But it seems unrealistic to us for the investor to endeavor to base his present policy on the classic formula—i.e., to wait for demonstrable bear-market levels before buying any common stocks.
- made provision for changes in the proportion of common stocks to bonds in the portfolio,
- if the investor chooses to do so,
- according as the level of stock prices appears less or more attractive by value standards.*