From the Archives: Beware CNBC and the Permabulls

On July 30, 2007 Jeremy Siegel — Wharton professor and author of the popular investment book Stocks For The Long Run — appeared on CNBC to give his take on the stock market.  To put things in perspective, this was before the credit crisis had erupted, at a time when the economy was still considered very strong, although there had been some cracks beginning to show in the facade.  The S&P 500, the broad measure of US equities, closed at 1,473.91 that day.   It was in the midst of a modest summer sell-off, having closed at 1,553.08 just 11 days before on July 19th (nearly the top of the stock market rally).

There were rumblings from certain corners of the investment world that the US housing market was in the midst of a major bubble that had the potential to drive the economy into recession.  However, investors like Mr. Siegel, who preaches buying stocks at pretty much ANY time (without regard to fundamental value) told CNBC viewers that the economy was humming along and there was no reason to panic.  He believed the housing market was a small piece of the economic pie and the global growth story would propel equity markets higher.

While we recognize that hindsight is 20/20, we think it’s important to note that if CNBC viewers had listened to Mr. Siegel and bought an S&P 500 index fund the next day, they would have enjoyed a two month rally into October of 2007, before watching a long and painful decline culminating in the March 2009 lows of 666.79.

And while the S&P 500 did rebound from those lows and post a twenty-six month rally,  peaking at 1,370.58 on May 2, 2011, that level was still 100 points below the price Mr. Siegel felt comfortable telling CNBC viewers to buy back on July 30, 2007 (and even when including reinvested dividends, the investment would still be under water).   Now that we are entering what appears to be another major stock sell-off, those same investors (assuming they held onto their initial purchase) will have to wait even longer to recoup their principal, never mind turning a profit.

Mr. Siegel, as evidenced by the title of his famous book, has built his reputation on an unwavering conviction that stocks will outperform almost any other asset class in the “long run.”   While we certainly agree that stocks can be good investments and have a place in most client portfolios, we also recognize they are amongst the riskiest asset classes available to investors.   For investors with a short time horizon (need access to their money in the near term), stocks, particularly during a market correction, can wreak havoc on a savings strategy.

Unfortunately, a cavalier approach to stock investing seems to be a problem for many investors.  The promise of outsized returns often seduces these investors into taking on far more risk than they should.  The financial services industry, which relies on the fees generated from investors taking on this risk, is often more than happy to encourage speculative behavior from their clients.   Compounding this problem are media outlets like CNBC, which benefit from increased ratings during bull markets, and have a vested interest in promoting a pro-market message to keep viewers tuned in.  After all, as an investor, if all your money was sitting in cash, why would you watch CNBC?

When we encounter a prospective client that needs help managing their investments, more often than not, it’s because they were too heavily invested in stocks (either on their own accord or through the advice of another adviser) and lost much more money than they expected.  Rarely do we encounter a prospective client that hasn’t taken on ENOUGH risk (all their money is in cash and they don’t know what to do with it).  As a result, our preference for downside protection over speculative growth resonates more with investors during market volatility.

While the stock market has experienced a severe sell-off over the past few weeks, it is still trading well above the lows of March 2009.  As I write, the S&P 500 is hovering around 1150.  Since we don’t own a crystal ball here at WSQ Capital, we don’t know for sure where markets are headed from here (we have an educated guess, but we don’t know with certainty). What we do know is that if we see a continued sell-off like we saw in 2008-09, higher risk portfolios with significant exposure to stocks will experience higher losses compared to those portfolios primarily invested in short term, investment grade bonds and cash.

So, when sizing up a volatile market such as the one we’re experiencing now, investors should ask themselves which they value more: downside protection or speculative growth?