The Investment Scientist

Posts Tagged ‘recession investing

“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.

“This sucker could go down!”

That was what President Bush said during the recent $700 billion bailout plan meeting with congressional leaders at the White House. The market has gone down another 20% and talk of another Great Depression has filled the airwaves ever since.

If you are a listener of Jim Cramer, you would have heard his advice: Sell, sell, sell! He constantly reminds his listeners how the Dow went down 83% during the Great Depression; and never fully recovered until 1954.

Cramer forgot to account for dividends. If dividends from the Dow stocks were reinvested, then investors would have been able to recoup all losses by 1945. That’s a full nine years sooner! Think about this: what if investors held only high-dividend stocks? Would they have recovered their investments even sooner?

To find out, I examined the following four portfolios’ performance from 1929 onwards:

  1. Portfolio A: stocks with zero dividends.
  2. Portfolio B: stocks with bottom 30% dividend yields.
  3. Portfolio C: stocks with middle 40% dividend yields.
  4. Portfolio D: stocks with top 30% dividend yields.

All four portfolios peaked in August, 1929. With the exception of portfolio B, all portfolios bottomed in May, 1933. Portfolio B bottomed in June, 1933. For each of the four portfolios, the total peak-to-trough decline (drawdown) and the number months it took to recover are presented here:

Buy at the top and hold during Great Depression
Drawdown 89% 86% 85.4% 84%
Months to recover 132 154 144 44

Data source: Kenneth French Data Library

It is probably not surprising that the highest dividend-yielding portfolio D fell a little less than other portfolios. It’s striking that portfolio D recouped all losses in just three-and-a-half years – eight to nine years before other portfolios.

Why did high dividend-yield stocks performed so well?

During the Great Depression, stock prices on average fell more than 80%. Dividends fell only about 11%. (See Chart below) As Yale University professor Robert Shiller has found, historically dividend volatility was about 15% of price volatility (meaning dividend declines were a fraction of price declines in recessions.) Stable dividend payments quickly made up for losses in price.

If the price gyration makes you dizzy, focus on dividends instead. They don’t gyrate and ultimately, they will sustain your retirement.

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

Twitter: @mzhuang

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