Stocks for the Long Run by Jeremy Siegel Part Four: Stock Fluctuations in the Short Run (Chapters 15-18)

Stocks for the Long Run by Jeremy Siegel  

The chapters are organized into five main parts:

• Part One: The Verdict of History (Chapters 1-4)

• Part Two: Stock Returns (Chapters 5-9)

• Part Three: The Economic Environment of Investing (Chapters 10-14)

• Part Four: Stock Fluctuations in the Short Run (Chapters 15-18)

• Part Five: Building Wealth Through Stocks (Chapters 19-20)

• Part Four: Stock Fluctuations in the Short Run (Chapters 15-18)

15.  Stock index futures, options, and spiders.
16.  Market volatility and the stock crash of October 1987.
17.  Technical analysis and investing with the trend.
18.  Calendar anomalies.

Here is a summary of Chapters 15 and 16 from Stocks for the Long Run.

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Chapter 15: Stock Index Futures, Options, and SPDRs

This chapter demystifies modern financial instruments and explains their role in the markets, while cautioning against their misuse by the average long-term investor.

• The Instruments Explained:

  • Futures: Contracts to buy or sell an index (like the S&P 500) at a set price on a future date. Used for hedging or speculation.

  • Options: Contracts giving the right (but not obligation) to buy or sell an asset at a set price. Used for income, speculation, or portfolio insurance.

  • SPDRs (Spider ETFs): Exchange-Traded Funds that track an index. The chapter highlights the SPDR S&P 500 ETF (SPY) as a revolutionary product that gave investors easy, low-cost access to a diversified basket of stocks.

• Impact on the Market: These instruments increase market liquidity and allow for sophisticated strategies. However, they also increase short-term volatility and market correlation. For example, program trading using futures can amplify sell-offs.

• The Long-Term Investor's Takeaway: Siegel's core message is one of caution and clarity:

  • For Speculation, Not Investment: Futures and options are primarily tools for short-term speculation or institutional hedging. They are not suitable vehicles for building long-term wealth for most individuals, as they involve leverage, decay (theta), and complex risks.

  • ETFs are a Breakthrough: Conversely, index ETFs like SPDRs are a perfect tool for the long-term investor. They provide instant diversification, low cost, and tax efficiency, embodying the book's philosophy of owning the broad market.

  • Stay in Your Lane: The chapter reinforces that the long-term wealth-building power comes from owning and holding productive assets (stocks), not from trading derivatives on them.

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Chapter 16: Market Volatility and the Stock Crash of October 1987

This chapter provides a deep-dive case study into one of the most dramatic short-term events in market history, extracting crucial lessons about volatility and investor behavior.

• The "Black Monday" Event: On October 19, 1987, the Dow Jones Industrial Average plummeted 22.6% in a single day—its largest one-day percentage drop ever.

• Causes Analyzed: Siegel dissects the perfect storm:

  1. Portfolio Insurance: Computer-driven strategies meant to limit losses by automatically selling futures when markets fell.

  2. Program Trading: These sell orders in the futures market triggered massive selling in the underlying stocks.

  3. Market Psychology: A feedback loop of panic as human investors saw the plunge and sold indiscriminately.

• The Crucial Lesson on Fundamentals: Despite the historic crash, no major economic news or corporate earnings disaster triggered it. The fundamentals of the economy were sound before and after. This proves that short-term market prices can become completely unmoored from intrinsic value due to technical factors and panic.

• The Recovery & Long-Term View:

  • The market ended 1987 slightly up for the year.

  • It recovered its pre-crash peak in less than two years.

  • For an investor who held through the crash, it became a mere blip on the long-term upward chart.

• Key Investor Takeaways:

  1. Extreme Volatility is Inevitable: Crashes and sharp corrections will happen. They are a feature, not a bug, of equity markets.

  2. You Cannot Predict or Time Them: The 1987 crash came without a clear macroeconomic trigger, highlighting the futility of trying to exit before a crash.

  3. The Only Defense is a Long-Term Plan: The investor's protection is a diversified portfolio and the psychological fortitude to not sell during a panic. History shows recovery always follows.

Connection Between Chapters 15 & 16

• Chapter 15 introduces the complex modern tools (futures, options) that, when used en masse by institutions, can contribute to market instability.

• Chapter 16 presents a real-world example of that instability (the 1987 crash), which was exacerbated by the very instruments from Chapter 15.

Together, they deliver a powerful one-two punch: The market's plumbing is complex and can create terrifying short-term volatility (Ch. 16), but the average investor should use only the simplest, most direct tools to own the market (Ch. 15 - ETFs) and must have the discipline to hold through the inevitable storms, trusting in the long-term trend.

Chapter 17: Technical Analysis and Investing with the Trend

This chapter examines the practice of technical analysis—predicting future price movements by studying past price charts and patterns—and evaluates its usefulness for the long-term investor.

• What is Technical Analysis? It is the study of market action (price and volume) to forecast future price direction. Practitioners use charts, moving averages, support/resistance levels, and indicators like the Relative Strength Index (RSI).

• The Allure and the Reality: Siegel acknowledges that technical analysis is popular because it provides concrete, visual rules for decision-making in an uncertain environment. It appeals to the desire to find order and patterns.

• Siegel's Skeptical View: While not dismissing it entirely, Siegel presents a largely skeptical view based on market efficiency and long-term data:

  1. Lacks Theoretical Foundation: It is not grounded in the fundamental drivers of stock value—earnings, dividends, and interest rates.

  2. Self-Fulfilling Prophecy: Its effectiveness can sometimes stem from many traders acting on the same signals, creating the predicted move temporarily.

  3. Poor Long-Term Results: Extensive academic studies show that most technical trading rules do not consistently outperform a simple buy-and-hold strategy over the long run, especially after accounting for transaction costs and taxes.

• Trend Following ("Momentum"): A specific form of technical analysis that involves buying stocks that are rising and selling those that are falling. Siegel notes that while short-term momentum exists, it is treacherous. Trends reverse without warning, and catching the reversal point is extremely difficult, often leading to buying high and selling low.

• Core Advice for the Long-Term Investor: Siegel advises that technical analysis is best left to short-term traders. For the investor with a multi-decade horizon, it is a dangerous distraction. The real "trend" to follow is the long-term upward trend of corporate earnings, which is captured not by chart-watching, but by patient, disciplined ownership of a diversified portfolio.

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Chapter 18: Calendar Anomalies

This chapter explores strange, recurring patterns in stock returns linked to specific times—like days of the week, months, or holidays—and asks whether investors can profit from them.

• Examples of Anomalies: Siegel catalogs well-documented seasonal patterns such as:

  • The January Effect: Small-cap stocks tend to outperform in January.

  • The Weekend Effect: Returns are historically lower on Mondays.

  • The Turn-of-the-Month Effect: Stocks tend to rise in the last few and first few days of a month.

  • Holiday Effects: Markets often rise in the days before a major holiday.

• Possible Explanations: These anomalies often have plausible explanations rooted in market structure and behavior:

  • Tax-Loss Selling: Investors sell losers in December for tax purposes and reinvest in January, boosting prices (January Effect).

  • Institutional Cash Flows: Portfolio managers investing inflows at month-end (Turn-of-the-Month Effect).

  • Settlement Procedures or a general mood of pessimism going into the weekend (Weekend Effect).

• The Practical Problem: Exploitation and Erosion. Siegel's key point is that once these patterns are discovered and publicized, traders attempt to exploit them. This very action arbitrages the anomaly away, diminishing or eliminating its profitability. What worked in historical back-tests often fails in real-time trading.

• The Verdict for Investors: Siegel concludes that while these calendar anomalies are interesting academic curiosities, they are not a reliable foundation for an investment strategy.

  • Too Small: The potential excess returns are typically small and erratic.

  • Eaten by Costs: Any profit is likely to be consumed by increased transaction costs and taxes from frequent trading.

  • A Distraction: Chasing these minor patterns distracts from the monumental, proven driver of wealth: long-term compounding in a diversified stock portfolio.

Connection Between Chapters 17 & 18

• Chapter 17 examines patterns in price movement (charts and trends).

• Chapter 18 examines patterns in time (calendars and seasons).

Together, they form a unified argument: The quest for predictable, short-term patterns in the market is largely a fool's errand for the long-term investor. Whether you're looking at a price chart or a calendar, these patterns are either unreliable, unprofitable after costs, or too small to matter compared to the overwhelming power of long-term, fundamental growth. The wise investor ignores this "noise" and stays focused on the "signal" of long-term ownership.