Once Upon a Time …

From time to time, it's a good idea to look to the past, in order to better project ourselves into the future. If we take a look back, the view is not a happy one. We've just gone through a rotten fifteen years from an economic and financial point of view. Of course, it hasn't all been doom and gloom, and there have even been some bright spots, but these have only been momentary, and in the end few investors can claim to have substantially increased their wealth since the end of the '90s.

The Swiss Market Index (SMI), Switzerland's flagship index, has gained 7% since January 1, 1998. This is a miserable result in the space of fifteen years. If we subtract inflation, which amounted to 11% over the same period in Switzerland, we even end up with a loss in real terms of 4%. Not a happy-go-lucky situation, given that the stock market is generally considered to be the best long-term investment (i.e. over periods of at least five to ten years).

The lucky ones will be able to console themselves with a few nice hits in 2003, 2009 and 2011. For the others, it's more like a soupcon, with some even giving up along the way, or feeling as if they'll never see their initial stake again.

Once again, dividends come to our rescue. Let's not forget that, historically, dividends account for almost half of stock market performance. To overlook the importance of dividends in such turbulent times is simply to shoot yourself in the foot. For example, if we look at the Swiss Performance Index (SPI), which, unlike the SMI, takes dividends into account, we see that over the same period the gain amounts to 58%. Even if we deduct inflation, this still leaves a total performance of 47%. It's not much, considering historical stock market performance, but it's already much better.

And to cheer ourselves up, we can look much further back in time. If we go back to the beginning of the last century, and look at the Dow Jones for a moment, we see that the stock market follows a regular 35-year cycle, with 20 good years followed by 15 bad ones.

From 1910 to 1930, the Dow rose from 98 to 244, gaining nearly 150%. Over the following fifteen years, however, it lost 38%, falling back to 152 points in 1945. Twenty years later, in 1965, it climbed to 869, gaining 472%. Fifteen years later, in 1980, it fell back to 824 points, losing 5%. But as the dollar's convertibility to gold was abolished by Nixon in the meantime, the greenback devalued by 63% against the CHF over the same period, resulting in a total loss of 68% for a Swiss investor over those sad fifteen years. The following twenty years, from 1980 to 2000, were nothing short of sensational, with the Dow rising from 824 to 11,357 points, gaining 1,278%! And while the dollar fluctuated against the CHF over these twenty years, it ultimately remained unchanged in 2000 compared to 1980, at 1.59. In other words, it's been a very prosperous period for investors!

The next fifteen years are not yet over, as they take us up to 2015. But we're very close. We've already seen that the SMI is anything but rosy. Since 2000, it has lost 11%. The Dow Jones is doing better, with a gain of 65%, but at the cost of a 40% fall in the dollar against the CHF. The gain for a Swiss investor is therefore 25%. Not a great return over this period, especially as inflation in Switzerland was 9% over the same period... indeed, even the CHF is losing value! Dividend-oriented investors have a bit more to smile about, as we saw above, but it's all very modest compared with what we can expect from the stock market, historically speaking.

Where it gets interesting is that we're 26 months away from 2015. We're 26 months into twenty years of stock market madness. Of course, for this to happen, the 35-year cycle described above would have to continue. But history has an unfortunate tendency to repeat itself. When things are going well, they seem to go on forever (the '20s, the '60s, the '90s...). During these periods, the benefits of the stock market make the headlines, everyone starts buying shares and companies recruit massively). Conversely, when things go wrong, it's as if there's no way out (the '30s, '70s and the beginning of this century). During these periods, the stock market and financial circles are decried in the press, small shareholders have been washed away by the markets, they've come out disgusted, there are only a few lunatics left who still buy shares, and companies are laying off people en masse. Sound familiar?

To add a final layer, let's take a look at gold. The Dow/Gold Ratio gives us the ratio of the value of the Dow Jones to that of gold. Let's take a look at its evolution in the chart below:

I've learned two lessons from this:

1. The Dow outperforms gold over the long term. Even if it's not obvious during certain turbulent periods, we can see that over the long term the ratio increases irremediably.
2. The Dow is currently undervalued relative to goldAs in the other "dark" periods mentioned above, and just before the years of strong stock market recovery.

At the start of this article, I said that it's good to look to the past to better project ourselves into the future. Having done that, I'm thinking that the hardest part is probably behind us. Even if we're not completely out of the tunnel yet, the light is not far ahead. Those who have stayed the course over the last few years will soon be rewarded.