Image credit: “Memoria (Memory),” Cornelis Cort, engraving after Frans Floris the Elder, 1560, Rijksmuseum, Amsterdam. The goddess Memory contemplatively records entries in the book of life.
By Jason Zweig
9:00 am ET May 14, 2013
For years on end, pundits have been predicting the collapse of the bond market, and recently such calls have reached a crescendo – with bond king Bill Gross of Pimco being the latest to sound the death knell.
But investors show almost no inclination to avoid the impending doom: A new survey of investors by BlackRock found that 57% are “worried about rising interest rates” and 53% think bonds are riskier today than a decade ago. Yet fewer than 7% said that “identifying the bond investments that are right for you” would be a major focus for them over the coming year – and 60% said they wouldn’t focus on it at all.
Meanwhile, even as the stock market has shot almost straight up for the past four years, investors appear to be turning their backs on equities. The proportion of Americans who will admit to owning stocks has sunk to 52%, down from 65% in 2007, according to a new Gallup survey.
In short, investors are the prisoners of their past.
As the late investment strategist Peter L. Bernstein liked to say, markets have memory banks. What investors expect is shaped by what they experience.
Bernstein was fond of pointing out that in 1958, when the yield on stocks fell below bond yields for the first time, Wall Street’s wise men predicted that it couldn’t possibly last. There was nothing else in their memory banks to draw on. For decades – centuries, in fact – stocks had always yielded more than bonds. So the reversal had to be temporary, they argued. But it wasn’t: Bonds went on to out-yield stocks for another half-century, to Bernstein’s bemusement.
By the same token, many investors – individuals and professionals alike – in the late 1990s had never experienced a protracted bear market in stocks. It was easy for them to imagine the future as an endless stream of double-digit gains. Never having seen even conservative stocks lose much money, they were eager to buy Internet stocks at any price.
Today, however, so many have been burned by bad markets that nearly 40% of U.S. investors believe they don’t need to own stocks to meet their long-term investing goals, according to another recent survey, from Franklin Templeton; 57% of younger investors felt that way.
And for all the chatter about the recovery in the housing market, Americans aren’t exactly finding it hard to curb their enthusiasm about real estate. Earlier this month, a survey of 1,000 people by Fannie Mae found that 51% – that’s right, half of them! – think that home prices will go up in the next 12 months.
Today’s bond investors have lived through more than three decades in which bonds almost never went down. So, even though everyone talks about the coming bear market in bonds, most people can’t imagine how painful it could be, warns David Allison, a partner at Allison Investment Management in Wrightsville Beach, N.C.
That’s true not just for individual investors but for professionals as well: The average age of a portfolio manager, according to the CFA Institute, is 43 – meaning that the last bear market in bonds ended when the typical portfolio manager was around 10 years old.
For today’s stock investors, the reverse is true. The past 13 years have been gut-wrenching, with the Standard & Poor’s 500-stock index collapsing 38% between 2000 and 2002, then roaring up until 2007, then losing half its value between 2007 and 2009, then bouncing back again. No wonder nearly a third of investors think the stock market went down last year, even though the S&P 500 gained 16% in 2012.
This phenomenon isn’t unique to our time; investors have always been captive to their memory banks.
Many of us know “depression babies” – perhaps our parents or grandparents – who grew up during the Great Depression and whose behavior has been shaped by that experience for the rest of their lives. They don’t just tend to pinch pennies tighter than younger people do. Depression babies also are less willing to take financial risks in general, invest less of their money in stocks and have lower expectations of future stock returns than younger people do.
In its 1948 Survey of Consumer Finances, the Federal Reserve asked approximately 3,500 Americans this question:
“Suppose a man decides not to spend his money. He can either put it in a bank or in bonds or he can invest it. What do you think would be the wisest thing for him to do with the money nowadays – put it in the bank, buy savings bonds with it, invest it in real estate, or buy common stock with it? Why do you make that choice?”
Mind you, this was nearly two decades after the Crash of 1929 and the onset of the Great Depression. Still, the wounds were salty and raw. Fully 34% of Americans said they wouldn’t put money into real estate because prices were “too high” and “capital loss [was] expected”; another 12% called buying a home “not safe, a gamble.” Only 9% were in favor of investing in real estate at all – but that towered over the paltry 5% who were willing to invest their savings in the stock market.
Note, too, that this kind of broad public loathing for an asset class is just what it takes to generate a high future return. Over the next decade, home prices went up by a cumulative total of roughly 12% after inflation, according to data from Yale University economist Robert Shiller; stocks gained an annual average of 14% after inflation.
Joachim Klement, chief investment officer at Wellershoff & Partners in Zurich, has argued that your attitude toward financial risk is shaped largely by the market returns you experience between the ages of 18 and 25, which he calls “the formative years” for investors.
The younger you are, the fewer experiences you have had time to deposit in your memory bank. So you will pay more attention to whatever has happened lately and, naturally, expect the future to resemble the recent past – the only history you have lived through. Research by Stefan Nagel, an economist at Stanford University, suggests that someone who is 30 years old places nearly twice the subjective weight on recent data as does someone who is 50 – and nearly three times as much as someone who is 70.
Bond investors who are over the age of, say, 55 know firsthand that bonds don’t always generate positive returns. When the bond market does finally tank, these are the people who will be in a position to buy from panicking younger investors who have never experienced such pain.
Sooner or later, older investors may well get the chance to benefit from buying bonds at the fire sale of a lifetime.
Related: In Honor of Peter L. Bernstein
Source: WSJ.com, Total Return blog
http://blogs.wsj.com/totalreturn/2013/05/14/markets-and-memory-banks/