The Only Chart True Investors Need to See

by: Keith Fitz-Gerald posted on: August 07, 2008 | about stocks: DIA / IVV / SPY / VTI    
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With all the negative news that’s right now permeating the global financial markets - hammering stock prices - we wouldn’t blame you one bit if you wanted to stick your head in the sand.

But before you cash out and take that escape route, there’s a stock market chart we’d like to share with you.

The point this stock market chart makes is very simple - and also very powerful. There will be wars, financial panics, recessions and depressions, political scandals and skullduggery, and even global financial crises. But the bottom line is that - over the long run - stock prices tend to head higher, meaning it pays to remain invested.

There are two key reasons why this is so:

  1. People are remarkably resilient, which means that our stock and financial markets are, too.
  2. Nearly every crisis that’s sent stock prices lower has ultimately proven itself to be a remarkable long-term buying opportunity.

Dealing With a Dour Outlook

Admittedly, with the stock market staggering, both those points are somewhat tough to embrace at the moment. We understand how you feel; we’re also struggling to come to terms with the same naysayers and doom doctors you hear on the news every day.

And it doesn’t become any easier when you look at short-term stock-market charts and see that the markets have officially dropped into "bear market" territory, with the broadly diversified Standard & Poor’s 500 Index having taken a 22.55% header since its record high last October. The U.S. economy is in the tank and the evidence is mounting that it’s going to stay there for awhile: After all, gross domestic product [GDP] is tepid, unemployment is rising, bank failures are continuing and the global credit crisis we’ve been dealing with is threatening to burn out consumers the way a California wildfire burns out homes.

No doubt about it: Right now, the overall outlook is bleak.

But, again, as the chart shows, these challenges are not insurmountable.

Especially, as I told a standing room only crowd of more than 1,000 investors at the "Agora Wealth Symposium" in Vancouver, B.C., recently, when you take two specific steps to put the odds as much as possible in your favor. Those two steps - which we talk about all the time at Money Morning - are the correct portfolio structure and protective stops.

The Dynamic Duo: Portfolio Structure and Protective Stops

Let’s look at the portfolio structure first.

As longtime readers know, we’ve recommended our proprietary 50-40-10 portfolio structure for years (50% "base builder" investments, 40% "global growth and income" plays and 10% the speculative "rocket riders). Not only is this mix time-tested (and, under the present circumstances, battle-proven), it ensures that we always have the right mix of conservative holdings and aggressive profit plays - no matter what the overall market happens to be throwing our way.

Here’s a brief recap if you’ve just joined us:

  • Our "Base-Builder" investments are the so-called "safety and balance" portion of a portfolio, and should account for as much as half its value. Conservative recommendations like these will help protect our money from severe declines - such as the "perfect financial storm" that’s upon us right now.
  • The "Global Growth & Income" portion of the portfolio, with its emphasis on dividends and internationally focused holdings, will serve as a thick layer of financial armor and a stream of cold hard cash to tide us through what looks to be a range-bound market for the foreseeable future. This should account for up to 40% of the portfolio’s holdings.
  • And, finally, our "Rocket Rider" plays will give us the spectacular upside potential that can beat the markets during good times - even though they constitute only 10% of our holdings.

Now let’s talk about protective stops.

No matter how you "feel" about the prospects of a particular company or even about the outlook for the stock market in general, we advocate the use of protective stops because they help us maximize profits even as they prevent small losses from ballooning into catastrophic ones. And that’s not just in bear markets, either. As the old Wall Street adage tells us: "You can never go broke taking profits." That means that protective stops work in bullish situations, as well as in bearish markets like the one we’re trying to navigate now.

Time and again we’ve heard investors tell us that protective stops cause them to second-guess themselves when they end up selling a company that appears to be trading cheaply or has good prospects. Those same investors tell us how they don’t "feel good" about cutting loose a company that’s a household name, or that is widely believed to be "too big to fail" (itself a badly flawed concept).

But in down markets that could go far lower, cutting loose your losers is precisely what you want to do.

Pan American World Airways, Eastern Airlines, Citigroup Inc. (C), The Bear Stearns Cos., MCI WorldCom, Montgomery Ward, Eastman Kodak Co. (EK) and Enron Corp. were all household names once upon a time, too.

Now they’re four-letter words.

And that’s why, in closing, we want you to begin each day by remembering the stock market chart we’ve shared with you today.

Tape it to your refrigerator, banker’s lamp, or computer monitor if you have to.

No matter how bad things could get in the months ahead, history (and this stock market chart) show the markets eventually will turn around.

Just when doesn’t really matter.

What does matter is how well you handle your portfolio and investments in the meantime. For that’s what will determine whether you’re among the losers or the winners when that stock market turnabout comes.

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Keith Fitz-Gerald

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This article has 24 comments:

  •  
    truthinvesti
    ng
    Aug 07 08:57 AM
    My Website
    Like the chart but why"speculate&quo... portfolio this year is up double digits which is documented on free website and NONE of teh stocks are speculative.Having said that ,the major PREMISE of holding stocks for the long term( unless the PE is over 20) is SOUND .
  •  
    buyitcheap
    Aug 07 08:59 AM
    Great chart and good article - a little bit worrisome though, as I feel a distant pressure that to ensure I have a long term gain I need to live 150 years. :-)

    It does put things in perspective for multigenerational planning.
  •  
    investor88
    Aug 07 09:13 AM
    The great point about this article is that even for longer term investments not just for trading we need PROTECTIVE STOPS. Without protective stops the outcomes in individual stocks can be disastrous. No quarrel about holding stocks for the longer term subject to protective stops. I wish to add one more point, we need protective stops not just for individual stock picks but ALSO for the bottomline of the portfolio!??
  •  
    knobsturner
    Aug 07 09:16 AM
    Look at 1962 - 1982: - 20 flat years. Looking at that chart, if anything, it shows that the market needs a breather like that again. I for one won't wait for 12 more years for the uptick! (We are flat since 2000).
    --Tom
  •  
    angrybroker.
    com
    Aug 07 09:32 AM
    My Website
    There's another chart that might need to be taken into consideration, making the only TWO charts that true investors need to see. Do a search for "chart of world oil production" and then go to the hubbertpeak dot com website (It should show up near the top of the search listings).

    I can't say that I'm completely on board the "peak oil" theory as yet, but you have to admit the correlation between these two charts is remarkable.

    There was slow, steady growth in the marketplace right up to the time that cheap oil (almost 'free' energy) made its impact upon the economy. Now, when you look around, nearly EVERYTHING is either built with, or facilitated, by this powerful source of energy.

    While the economy is predicted, by your chart and your article, to continue ever-upwards, our cheap oil at some point begins to diminish. This even as India and China decide THEY all want cars and a suburban (i.e. drive around a lot) lifestyle just like us Americans.

    Of course you've got "experts" telling us that we're not running out of oil, but when you read between the lines, no one said we're "running out" -- what's happening is we're getting near to have pumped out half of the recoverable portion. At that point, production goes down. It HAS to go down.

    The interesting thing will be to see how this affects your stock market chart when it happens, whether it's in the next few years, or 30 years from now...
  •  
    sponger
    Aug 07 09:55 AM
    Precisely, buyitcheap. Factor in inflation and it's a zero sum gain in 150 years. Even in 1937 Lobster Thermador Honeymoon Special for Two with a split of world class champagne cost 87 cents (before
    tip) at a major hotel restaurant in New York City (evidenced by my
    parents' scrap book).
  •  
    John
    Pseudonym
    Aug 07 09:56 AM
    Well, it looks like if you live to be 137 years old, you'll have a gain in the stock market.

    What about inflation since 1871? I want to see the inflation adjusted chart; now that would be a site to see.

    The "buy and hold" era has ended (for now). Anyone blindly "playing the market" will be lucky to still have their original investment a few years from now.

    This market is for the nimble and requires constant attention.
  •  
    Malkiel
    Aug 07 10:14 AM
    "Just when doesn’t really matter"

    Wrong, wrong, wrong, when you buy is almost the only thing that matters, much more important than your little portfolio mix formula. I can't remember which author went over this ground, but there's probably more than one analyst out there who's pointed out that people who did their buying at market tops did much worse in the long term than buyers who did their buying at market bottoms. The people who were fully invested in 2001 before 9/11 have still not caught up after 7 years with the people who got fully invested in 2003, and that interval may push out to 10 years or more. The person who got fully invested in 1929 before the crash appears not to have caught up with the person who got fully invested in the '30's until around 1991.

    Choosing a variety of stocks on the basis of some diversification formula doesn't ever rescue you from the need, at some point, to make a market timing choice. Your entry point and your exit point are crucial to your success and they are market timing matters, and no amount of puritanical dislike of market timing nor nostalgia for "value" investing can erase that problem...
  •  
    debtacid
    Aug 07 10:49 AM
    Well, I could suggest at least one more chart. The dollar value chart which shows a much steeper decline. The only thing "True Investors" have been investing in is inflation and that's a fools game. All we have to show for the last hundred years of "investing" is crushing debt.
  •  
    LarryH
    Aug 07 11:09 AM
    Anyone who does not have a 10 to 15 year time horizon must be very careful about stocks right now. We have had flat periods of that duration before, and we may be at the beginning of another one. Some would argue that we are already a few years into such a prolonged subpar market. Be careful out there.
  •  
    bbzz24
    Aug 07 11:19 AM
    Keith,
    You seem to have very looooooooooooong time horizon.
    And on top of that measure in dollars that simply have not been the same for quite some time. Returns since the Fed was was established are 100 times. Yet the currency has been devalued 22 times. Then there are 3 trillion of USD withdrawn from circulation after single use (in China/Japan/Saudi Arabia). Which comes to uhh... 35% of the total value. Why are those 3 trillion so important? They have been churned through the system once and then withdrawn (profits booked and distributed). If that money is used to purchase real stuff it will ruin the value of the dollar and your return will simply turn out negative.
    Being average does not cut it on the football team, does not cut it in the SAT tests, why should it be fine when it comes to investment?
  •  
    bbzz24
    Aug 07 11:26 AM
    In case you wonder what your wonderful returns over holding gold are since the Fed was put in place: 1.81% per anum. Sounds spectacular?
  •  
    nayr
    Aug 07 01:06 PM
    My Website
    Yeah, I would like to see this whole article re-written with inflation taken into account. With inflation, that chart starts to look pretty lame considering time-value.

    concisetrading.blogspo.../
    Ryan
  •  
    paranakyry
    Aug 07 01:22 PM
    This can't really be looked at as investment advice, because it's a sales pitch. Both timing and inflation are important and, as knobturner so aptly points out, the graph shows that the market is ripe for a protracted sideways move. The post should read "The Only Chart True Salesmen Need to Use."
  •  
    ardano
    Aug 07 03:48 PM
    Here are a few other overlays...First. Consider that the 1871 through the early 1900 time frame could be linked to the passing of the global leadership torch from the UK to the US. History teaches us that the winners of wars write history and gain economically.

    The next phase, through the 1929 crash to the New Deal is similarly politically oriented. We had a technology boom...the industrial boom. Creative destruction got us both the roaring 20's and the depression later. Boom and bust. It took the combination of the New Deal and winning WW 2, that again allowed the US to write history and establish bedrock capitalist roots throughout Europe and Asia. Again, the US was the key benefactor. Look at the growth curve from the end of WW2 through the 70's. You don't have to be a genius to understand the US led the world and our economy boomed.

    What about more recent history? We finally won the cold war and unleashed another wave of capitalism. Remember the peace dividend? Then we had another revolution, the information technology revolution, that sparked another extraordinary economic boom. However, like the industrial revolution before it, creative destruction begat the dot.com bubble. The difference to me is rather than deal with the issues regarding the dot.com roaring 90's, we rolled the problem into the real estate bubble. What's changed to alter the view of the chart?

    My fellow alpha readers are right to point to, energy, currency valuations, (a function of global markets for goods,) and maybe the other chart not viewed, political leadership.

    The current housing/credit crisis will be more difficult to solve because the US will have difficulty generating the equity required to liquify both our banking/credit system AND consumer balance sheets.

    If we get another big leg up from here it will be because politically we reach agreements with key global powers, think OPEC for energy and China for industrial production, and trade agreements. We have to win the wars we are currently waging and prevail at the bargaining table on multiple trade treaties. If not, we could endure years of below par growth.
  •  
    akapital
    Aug 07 04:37 PM
    Good article, some great comments on historically flat periods and time horizon...but one thing I would point out that I do not believe has been mentioned yet is that regardless of the "market" per se, there are some great investments out there. Another words there are some great stocks regardless of how the overall market or indexes perform.

    I think if one spends enough time studying key sectors one can pick up on what industries will outperform. In my opinion one such opportunity for the foreseeable future it is alternative energy. Perhaps this distinction becomes moot if and when indexes add what are today considered peripheral to the economy but which become central later. But still there is always the opportunity to realize this before the market does.

  •  
    Drewriders
    Aug 07 05:37 PM
    Great chart.... If my name is Methuselah!!!!!

    Most people I know didn't start investing in 1871. How is this going to help anyone who is trying to retire right now?
  •  
    Eagle-Chief
    Aug 07 07:53 PM
    You're just a Wall Street Stooge, Mister. Sure, stock prices may go up, but you could also buy a house for $20,000 in 1970 (in many places). Increasing prices don't always mean increasing wealth. REMEMBER THE INFLATION MONSTER ! People have been losing money right and left in this MASSIVE BEAR market. So if you say that this is the only chart we need to see (ie-"all we need to know") - my response is "HOGWASH."
  •  
    moonplantr
    Aug 07 10:50 PM
    Yeah, what a huckster's hoax ... considering that 90+ % stock issues making up the indices 100 or even 50 years ago are now extinct. Go figure, a fool who simply buys and holds under the circumstances not even considering inflation's theft. Wall Street is no different than the Casino ... the house advantage and vigorish breaks you in two in the long run if you're naive to think the stock market is a failsafe money making machine. It may just take longer to fritter away your stash to the street profs. As in the Casino you better cash in your chips when you're fairly ahead and limit/cut your losses ... don't be greedy, play with a short bankroll or not know the rules of the game. Set goals and excercise dicipline. Putting your money in the market is as risky as the roulette table or rolling the dice. Don't believe the hype of buy and hold that the hucksters spin endlessly.
  •  
    skd
    Aug 08 05:15 AM
    Interesting chart, would be more relevant if it were real S&P rather than nominal one. Market does go up and down with inflation, taking the inflation effect out would show the real investment growth/returns.
  •  
    Pretzel
    Logic
    Aug 08 05:27 AM
    Lmao! Looks like this crowd is a little too smart for buy-and-hold propaganda. That crap might work on John and Mary Lunchbucket trying to decide which mutual funds to stick in their 401K, but it obviously ain't workin' here. All I have to say is: look at the 1929 peak on your chart, and then look at where the market finally hits a higher high -- decades later. Sorry, but most of us aren't interested in waiting 20 or 30 years just to get "even" in devalued dollars.
  •  
    bits
    Aug 08 12:45 PM
    Like others who commented above, I would love to see your chart adjusted for inflation. Since the Federal Reserve was created in 1913, the US$ has lost 95% of its purchasing power. So by my math, the S&P Index has grown from $10 to $64 in real terms over the past 95 years, although the nominal value has grown from $10 to $1,280. Factor in taxes on the real $54 gain over 95 years and there is not much left to brag about.
  •  
    truthinvesti
    ng
    Aug 09 09:57 AM
    My Website
    Enjoy this spirited debate. I have been allocating assets for 22 years now and can tell you that the KEY is buying the right stock at the right time and having the guts to average down PROVIDED YOU pick the right stock.Myfreewebsite has documented the over double digit returns on longs in this"supposed bad market".Over 30 purchases ,some buy and hold some are sold after they reach a certain level. Last year many boght stocks like Grmn and Whole Foods and Chipolte and WM and C MER and others and they are finding out they were "mistaken" to buy at poor levels
  •  
    bearfund
    Aug 09 04:10 PM
    Your own chart shows that between 1899 and 1941 an investor made nothing but dividends (not that dividends are anything to sneeze at). Thankfully, the US was on the gold standard the entire time, so the ravages of inflation were not so pronounced. Nevertheless, the dollar was significantly devalued in 1933, so if you held for those 42 years, you lost about 30% of your total purchasing power. A similar argument could be made for 1962-1981, especially after factoring in the ferocious inflation of the 1970s. Are these periods cherry-picked to look bad? Sure they are. But the point remains that equity appreciation is highly cyclical with a long wavelength, and big run-ups tend to be followed by a decade or two of sideways action. This is what people mean when they talk about the 35-year hard/paper asset cycle.

    There is no reason to think we don't face another 8-12 years of sideways action in stock prices.

    If, as in the early 20th century, stocks priced in dollars and stocks priced in gold had the same price behaviour, it would not be so bad to sit back and collect 3% dividend yields. Unlike then, your dollar loses 5-10% of its value every year. It's lost 95% of its value in the last 37 years. So a 30% nominal total return over the next 10 years isn't going to help me meet my financial goals.

    The best argument you could make to convince me to buy stocks now is that since 1963 stocks have not appreciated at all in real terms - about the same length of time as the long drought in the first half of the 20th century. Unfortunately, the rest of your platitudes leave me lacking whatever confidence that might give me. In one breath you say "Nearly every crisis that’s sent stock prices lower has ultimately proven itself to be a remarkable long-term buying opportunity" and in the next you note that "Pan American World Airways, Eastern Airlines, Citigroup Inc. (C), The Bear Stearns Cos., MCI WorldCom, Montgomery Ward, Eastman Kodak Co. (EK) and Enron Corp. were all household names once upon a time, too. ... Now they’re four-letter words." Well, which is it, then? Are downturns great buying opportunities or are they waypoints on the journey to zero? Rome was once a tremendous world power. Now it's a tourist destination in a minor (and floundering) nation. There is little fundamental reason to think that the United States will do much better. The only question is whether its collapse lies on the other side of one or more dramatic recoveries. You've done nothing to shed light on that question.
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