Tuesday, January 30, 2018

Stocks and Apples

I don’t like to write about the stock market. While the values in the stock market are often related to global macroeconomics, the changes more often mirror my dance moves after a night of consuming JD. But like a good bottle of JD, it is not easy to ignore Da Market.

So today I focus on Da Market as measured by something called the Wilshire 5000. The Wilshire 5000 is not as well known as its cousins: the  DJ Average, the S&P 500, or the NASDAQ. Wikipedia defines the Wilshire index as a market-capitalization-weighted index of the market value of all stocks actively traded in the United States.

I am writing about the stock market because we are obsessed by it. Everyone watches the market indices daily and we cheer its upward advances. More popular than the Philadelphia Eagles, we can’t wait until its next upward movement. But nasty people called shorties tell us that the market, like the apple that supposedly hit Newton on the head, must come plummeting down to earth. With apples, they cite something called the Law of Gravity. With stock prices, it all has to do with Pee Wee Herman or PEs or something like that.

Apples or stocks, what goes up must come down. So I decided to look at the data today and report to you what I found. Take a deep breath – there is no forecast here. Do with it what you will.

Before we begin looking at my huge table below, let’s make one point. The Wilshire 5000 went from a value of 3,291 in 1990 to 27,655 in 2017. When it comes to these 28 years, it is pretty clear that Newton had nothing to say about stock prices. If my calculator is correct, that amounts to a nominal capital gain of 742%. I will take that.

But let’s not stop there. Most people are not as conservative as me. Call me Buy and Hold Larry. Other people are more active in stock markets. Others might have a shorter horizon than 28 years. That’s who my wild and crazy table is for.

What’s in the table? Betty wonders what I do in my office all the time. Basically, I make up tables and rearrange the flowers in my JD bottles. Anyway, the table below was created by going through 324 months of data, one month at a time. I found there were 10 time periods between 1990 and 2017 in which the value of the market peaked, fell for at least a few months, and then returned to its previous peak. The idea of this kind of breakdown is to see what happens after stock prices begin to slide.

Begin with the first row of the table. In June of 1990, the market peaked and was 5% higher than the previous peak. After June of 1990, stock prices fell. They fell and then rose until reaching the previous peak in June 1990. It took 9 months to regain that previous peak. 

This down-up pattern happened 10 times since 1990. Typically prices began falling after a 22% increase since the previous peak and then took about 20 months to fall and then rise to reclaim the previous peak.

But notice there are large variances among the 10 time periods. Half the time, it took 10 months to recover. But notice that in five of these episodes, it took 5 months or less for stock prices to recover. And then there were the episodes in 2000 and 2007 where it took 81 and 63 months, respectively, to regain the previous peak.

It is pretty clear from the table that the time it takes to return to a previous stock price peak is highly variable. Many times it took less than half a year. The average time is less than two years and the median time is less than one year. And then – tada – there were two times when it took 5-7 years. So if the stock market does seem to rise over time, your recommended behavior very much depends upon your time horizon. If you can live through poor stock markets for 7 years – then the past suggests you have no worries. Buy a sailboat. 

The final table column is interesting too. It lists the percentage change from the previous peak to the subsequent peak and downturn. For example, the second line in the table says that between 1990:6 to 1994:1, the stock market rose by 37%. It was after that 37% increase that led to stocks subsequently falling and then rising again. In the case of 1994:1, a previous increase of 37% led to a 13-month cycle. It is interesting that the longest cycles in the table (81 and 63 months) were preceded by relatively modest increases in stock prices of 12% and 10%. The 42% increase in stock prices before 2015:7 surprisingly lead to a down-up cycle of only 11 months (before prices returned to previous highs).

In short, there does not seem to be any correlation between previous stock price increases and subsequent months of return to the previous peak stock price. And thus the 25% increase in stock prices between 2015:7 and 2017:12 does not warrant any special concern from the standpoint of this analysis.

When will prices hit another peak? I am not sure. But if and when stock prices begin to fall, this analysis suggests that the time before the next peak might only be a few months. Of course it might be 8 years too. Those who would scare you out of stocks right now ought to explain to you when they think stock prices will fall – and then when they will return to the previous peak.  

Peak      Months    Wilshire Percent
               To Next    Value      Change
1990:6      9             3,446            5
1994:1     13            4,709          37
1996:6       4            6,629          41
1997:2       3            7,647          15
1997:10     4            9,215          20
1998:7       5          10,822          17
1999:7       4          12,640          17
2000:3     81          14,096          12
2007:10   63          15,556          10
2015:7     11          22,097          42
Average  20                               22
Median     5                                17


  1. If it falls...stay in the game....buy the lower priced shares that have fallen and hold as they rise....or get a hedge fund.

  2. I recently executed a trailing stop limit loss of 5%--meaning that a sell order occurs when a stock falls 5% below its high during the time you own it. This preserves profit (limits loss) and allows repurchase of the stock if it starts to rise. Intended to limit loss if/when a sudden/sustained drop occurs. Staying in the game only to resume buying in the future has four drawbacks: 1) Your loss may continue during a fall and one doesn’t know when the bottom is reached so your loss builds up; 2) You might not know when to get back in the game so you wait and incur more loss (a distant cousin from Alabama to #1); 3) If the stock pays dividends you lose those when you’re outt’a de game; 4) At our golden ages there might not be sufficient time to regain the losses. Most advisors say stay in the game ‘cause stats show those who stay out lose a lot over the long term when stocks rise. This, of course, implies the investor has lots-0-time (refer back to #4 and see 2nd corollary below). But there are strategies to limit loss—e.g. stop losses and stop limits. Professionally managed accounts might not offer stop losses/limits because they need time to liquidate the funds—and the losses might increase until liquidation; 2nd corollary—advisors get their fees no matter if you gain or lose so it’s in their interest you stay in the game. However, if you manage your own portfolio you likely have the option of stop losses/limits.

    Dear LSD. Likely you didn’t intend the blog to take on investment advice. But, the value of the advice is = to the $$ paid fer it.

    1. Nice work Tuna. I am sure a lot of people can value from your analysis.