The Investment Scientist

Has the market hit bottom?

Posted on: December 9, 2008

“Successful investing,” in the words of British economist John Maynard Keynes, “is anticipating the anticipations of others.” In this vein, a market hits bottom when most people think that most other people think it has hit bottom. Only then, most people start to buy stocks, creating a self-fulfilling prophecy. If most people think the market should hit bottom, but they also think that most other people don’t think that, they won’t buy stocks and the market will continue to drop. So, predicting when a market will hit bottom is a mind game on a grand scale. If there are people who are good at that, I am certainly not one of them.

Prescience not needed, discipline required

Now let me ride a time machine to January 1929. Let’s say I committed to invest $100 every month in the S&P 500 index. I did not have the prescience to know that the market would crash in October and the Great Depression would follow. But if I had the discipline to carry out that investment plan over 30 years, the table below summarizes what would have happened to my investment through the worst stock market period in history.

Year from Jan 1929 Total invested Portfolio value Total dividend received Total gain (loss) Dividend contribution to the gain
1st year 1,300 1,115 23 (161)
2nd year 2,500 1,779 98 (623)
3rd year 3,700 1,737 230 (1,734)
4th year 4,900 2,771 415 (1,714)
5th year 6,100 5,547 629 76 100%
10th year 12,100 12,835 3,024 3,759 80.4%
20th year 24,100 30,786 13,683 20,369 67.2%
30th year 36,100 135,992 47,960 147,852 32.4%

Data source: Professor Robert Shiller’s website

The total gain from my investment plan is the portfolio value plus total dividends received minus total money invested. As you can see, though I suffered losses in the first four years, I had a small gain in the fifth year (January 1934)! This result is not bad, considering that between1929 and 1934 were the worst years for the stock market (an 89% drop) in history.

For the first 10 years of my hypothetical investment, dividends accounted for 80.4% of the total investment gain. This means that if I had invested in high dividend stocks, I would have done even better. (Also see my newsletter article, “Dividends to the rescue in a Great Depression“.)

Here is the take-home lesson from my time travel experiment: to recover from the market crash and to survive a recession, however deep, you don’t need prophecy, just discipline and patience.

The author is president of MZ Capital, a RIA serving DC/MD/VA. Get his monthly newsletter in your mailbox or get to the directory of his past articles.

1 Response to "Has the market hit bottom?"

[…] Comment! In January of 2008, I correctly called the beginning of this recession. However, I was totally off the mark about the severity of it. Now we know this recession is far severe than any we’ve seen since the second world war, the following research is therefore no longer applicable. The proper reference would be the Great Depression. Any investment strategy should stand up to the stress-test of the Great Depression.  I studied the effect of dividends and the that of discipline. […]

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Michael Zhuang is principal of MZ Capital, a fee-only independent advisory firm based in Washington, DC.


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