Elroy Dimson, Paul Marsh, and Mike Staunton*
"In this article we show that, historically, annualized long-run equity returns have not been as high as 10 percent in real terms anywhere in the world. Over the past 103 years, a more typical figure has been 4–6 percent. Furthermore, a careful analysis of historical returns indicates that future risk premiums are likely to be lower than in the past. We challenge the widely held view that over an interval of up to 20 years, equity investment is sure to provide a positive real return. Equities are not “safe” in the long run."
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Despite what you might think, I do work hard at trying to be objective, though I admit that I have hand wringing tendencies! My Dad is a complete "the end of the world is nigh".
What continues to fascinate me is the role of our beliefs and behaviors--and how normal it all seems until one peels back the skin. I think that this article does a nice job of peeling back the skin on our belief that over the long haul we will always do better with equities.
I don't wish to sound like a CT (conspiracy theorist), but when one thinks about the amount of fees associated with the financial markets, it's in the interest of many many many people for us to feel comfortable about "being in for the long haul".
Reading this article juxtaposed with my reading Mauldin's most recent letter he has one of his invited writers talk about fat tail risk. Here's a lift from the letter:
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Focus on fat tail risk
Now, what investors really should worry about is what we call extreme risk –
3-6 SD events which can potentially wipe out years of profits. This is often
referred to as fat tail risk. It is to be found to the extreme left of
chart 1 (encircled in red). However, according to the text book, they do not
occur very often. Take a closer look at the following table:
![[Table 1]](https://lh3.googleusercontent.com/blogger_img_proxy/AEn0k_uexQwdxc3JURfGMf5zbHyR6m2fgOZuLgXX79Y57kwWlYn-ws1md6Weaobu4tz6WXCjuT_2KiU0rpwwu74tJEYLQ5FrDVHVIpUsmIS8DPxuMAkKeQI6MtLmUD_YSUFMYHKyiZutnA=s0-d)
Once every 3 billion years?
Statistically, assuming you are not an 'über human' vastly outliving the
average person on this planet, you should experience only a couple of 2 SD
events in a lifetime. The problem is that recent years have been littered with
6, 7 and 8 SD events. A 7 SD event equals 1 every 3 billion years or
approximately the lifetime of our planet. Since the 1998 Russian debt crisis,
financial markets around the world have experienced at least 10 extreme shocks
none of which were supposed to occur more than once every few billion years.
The point about current risk models not properly valuing extreme risk was a prominent point in the paper Hedge Funds and Systemic Risk that we reviewed here back in March/Apr.
I did close my RIMM puts out for a decent gain (37%). I'm still holding fast on FAST, though it has been remarkably strong (which I'm attributing to the massive short interest that still needs to cover). My puts are up marginally.
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1 comment:
The paper was sited in an Economist article I read (Oct. 6 Issue), Buttonwood: To Infinity and Beyond. The article noted that there were investors in the Japanese, French, German and Spanish markets that would have had to wait 50-60 years to see a positive return. And the returns that were noted do not factor in the Russian and Chinese markets that disappeared and never returned.
It notes that the very belief that the market will always go up tends to bid it up to collapse points: siting Japan in the 1980s and NASDAQ (still at only slightly better then half its peak value seven years later) in the 1990s.
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