Our Theory of the Capital Markets, On the Back of a Postcard

From the April 2019 issue

• For about the last century, the compound return of mainstream equities—at seven percent—has been 2.3 times that of comparable bonds. This premium renders bonds an irrational long-term holding in lifetime/multigenerational investment portfolios.

• For much of that time—and consistently since 1960—the blended cash dividend of mainstream equities has grown at rates approaching twice that of consumer inflation.

• The cost—in essence, the driver—of these permanent returns has been temporary volatility. Just since 1980, the average intra-year drawdown in the S&P 500 has been almost 14%. About one year in five, the temporary drawdown has averaged more than twice that. But at 2,800, the S&P 500 has risen 25 times from its level on the first day of 1980.

• In an efficient market, anything that suppresses temporary volatility must concomitantly suppress permanent return. The suppression of temporary volatility is therefore an irrational long-term investment objective.

• Moreover, the equity market cannot be consistently forecast, much less timed. The only way to be sure of capturing the full permanent return of equities is to remain fully invested during their temporary declines.