Is buy-and-hold dead?
Segment originally aired March 14, 2003
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KAREN GIBBS: We're certainly longing for some resolution to the Iraqi situation. The stock market is preoccupied with every subtle nuance and not so subtle rumor. But should war make a difference in how you invest? Are bonds the place to be or are we poised for a big stock market rally? And can we feel safe once again with the buy-and-hold strategy or should we try and time
the market?
Kathleen Gaffney of Loomis Sayles is here to support the bond argument, while Jim Paulsen of Wells Capital Management suggests tactical asset allocation. Jeremy Siegel, professor of Finance at the Wharton School of Business and author of Stocks for the Long Run joins us via remote to tell us why we should always be in the market.
Welcome everyone.
Jeremy, let me ask you, what are the effects of war on the market long- and short-term?
JEREMY SIEGEL: The effects are very different depending on what war you look at. In World War I, we went way up in the market. World War II was not good for the market, neither was the Vietnam War, but the Gulf War did a lot of magic for it. So it's hard to take a lesson that's consistent from war time on the stock market.
GIBBS: So how should investors respond to all this noise?
SIEGEL: Well, that's the whole point, is that so many things are happening, no one knows which way the market will go. We do know the market hates uncertainty. Some resolution one way or the other is going to bring that market up eventually. You don't want to be out of the market when it has these big gains.
GIBBS: Kathleen, people have been pouring money into bond funds. In fact, your fund has been really doing well performing, about 7.4 percent returning for investors over the past three years now. With rates so low, is there any upside left for investors to jump in now?
 KATHLEEN GAFFNEY: Corporate bonds are a great place to be right now. Yes, government bonds are low, but there's a significant yield advantage on corporates. Low rates of about 1.5 to 2 percent short term. In corporates you can pick up 4.5 to 7.5 percent on high quality investment grade bonds. That's a pretty exciting opportunity we believe.
GIBBS: Jim, what do you think about the bond market versus the stock market right now?
JAMES PAULSEN: Well, I like the stock market better right now, Karen. I think the pessimism that exists is probably a little overdone, and we're probably at odds for an optimistic outcome I think, and that could cause a rally in stocks here in the next year or two. And if it does, then I also think
that interest rates will go up, which will tend to hurt bond returns.
GIBBS: Certainly it would hurt bond returns. But right now, we see a lot of problems in the economy that don't really necessarily augur for a stock market rally. Look at the overcapacity.
 PAULSEN: Yes, I think that's always the case, though, in market bottoms, that there's very little to point to, except the fact that stock prices are down a lot. There's always a host of problems, and oftentimes big bull runs come out of periods where there's great risk.
GIBBS: Jeremy, tell me about your big picture here. What do you see right now in the underlying economic situation?
SIEGEL: I tend to agree with what Alan Greenspan said to a Congressional committee just a month ago. He said the cloud of Iraq is so strong, it's hard to see what the inherent strength of the economy is going to be. That's probably why I think the Fed is going to hold next week. We need some clarification there (regarding possible war with Iraq).
My feeling is the monetary stimulus and the fiscal stimulus that has already been applied -- I'm not speaking of what we might get into the future -- is enough to send our economy upward in the second half of the year, assuming that there's no major negative repercussions from the Iraqi situation. So I am hopeful about the economy. It's weak this quarter -- all the uncertainty on war, the blizzards in the Northeast. We've had all these negatives, and yet we're still going to have 1 to 2 percent GDP growth, looking a little better next quarter -- in the second half of the year looking stronger yet.
GIBBS: Kathleen, is that why you prefer corporate bonds over Treasuries?
GAFFNEY: Yes. The great thing about corporate bonds is that you're paid to wait. I agree with Jeremy. There is a lot of uncertainty out there right now, but it's a question of timing. Is the economy, once the war clouds dissipate, is the economy going to be in good shape? We're not so sure. But with significant yields there, we can be a little bit more patient, and that gives us a lot of comfort right now.
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Stocks vs. bonds
Wharton professor Jeremy Siegel produced what might be the buy-and-hold crowd's favorite statistic: he discovered that $1 invested in the stock market since 1801 would have been worth almost $7 million at the end of 2002, assuming all returns were plowed back in the market. According to Siegel's research, $1 kept in bonds for those 200 years would have been worth a relatively paltry $15,609.
Open-and-shut case for holding onto stocks, right? Not necessarily.
Academics can tell investors to hang onto index funds through bad times, but the real world includes layoffs, medical bills, accidents, emergencies, car and home purchases, college and caring for elderly relatives -- to name just a few things that force people to open the vault early.
The most significant cost might be your own retirement. When you're no longer working, you can't let your investments sit around so you can avoid taxes and fees; your assets have to produce gains immediately. And though stocks blow away everything else eventually, Siegel's own figures show that bonds outgained stocks in 78 of the past 200 years, or almost two out of every five years.
There have been periods as long as two decades when bonds have been better havens for your money -- including the last 20 years. According to Siegel's data, that $1 placed into 1801 stocks was worth $760,577 in 1982, and $6,963,102 last year. Siegel also indicates the 1801 dollar in bonds was $1,611 in '82, and $15,609 two decades later. The math speaks for itself: Stocks rose about 816 percent ($760,577 to $6,963,102) over the last 20 years. Bonds gained 869 percent ($1,611 to $15,609).
That doesn't mean you should buy Treasuries right now. After all, 20 years is about the longest stretch for which bonds outperform stocks, and we reached that point in 2002. Also, interest rates are at a 40-year low, so over the next few years they're much more likely to increase, thus hurting the fixed-income market.
But the numbers do show that an unrelenting grip on stocks can hurt investors who can't afford to wait decades -- and demographics guarantee that group will be increasing soon. If population trends have held up since the last census was completed two years ago, more than a quarter of the U.S. population is old enough for Medicare or will be eligible in a decade or less.
-- Sergio G. Non
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GIBBS: Jim, investors have been listening to the gospel of buy-and-hold. Are you singing from that hymnal?
PAULSEN: I think the days of buy-and-hold have been great here for the last 20 years during this great bull run, but I think we're into a trading range stock market.
That doesn't mean the stock market will never go up again. In fact, I think the next couple of years it's going to go up pretty good. But it does mean I think it's going to be more choppy, and whereas you could buy and sit on stocks for 20 years in the past, I think in order to make incremental returns now, you're going to have to allocate a little bit, sometimes weight the stock market more and sometimes weight the bond market more.
GIBBS: Jeremy, you've done a lot of studies over the years looking at just this asset allocation picture. What have you seen, and is it now time to stop the buy-and-hold?
 SIEGEL: I've been curious how everyone, as what we've seen in this bear market, approves that buy-and-hold is wrong, because my research, and everyone else's research, has been through both bull and bear markets. When I found that the long-term investor returns between 6.5 and 7 percent a year after inflation, I included all those bear markets.
If you can do some timing the way Jim suggests, you'll get even higher return. I just find very few investors and even professionals are able to do it. If Jim is (able to time the market), you know, all the power to him. I hope he succeeds. It is very risky for the average investor. The average investor, when times are optimistic, he or she gets too much in the market; when times are scary, such as now, that's when they get out, and that's when the best returns can be realized.
PAULSEN: I've just got to say, Karen, I don't think investors want to go out of the stock market. I think they want to maintain their long-term investment parameters.
But I think you've got to kind of go with what the market's giving you. The last 20 years, staying in stocks and never moving away was the right thing to do. But for a period of about 15 or 16 years from the late '60s to the early '80s, the stock market was absolutely flat, and staying with buy-and-hold might work out over a hundred years, but it took 15 years where you went nowhere.
I think in the next 10 years the market could be flat, and to try to add a little return upon just a flat overall market for the next 10 years I think is worthwhile at the margin, not to go 100 percent stocks or 100 percent bonds, but maybe to move 10 percent one side or the other over your mean parameters.
GIBBS: Kathleen, you've found some very good values in companies where the stock has caused investors to lose money. Can you talk about that, particularly looking at Ford?
GAFFNEY: Sure. That's an interesting name when you think about uncertainty in the marketplace, and we have seen the stock go down. Ford is really a poster child for uncertainty, but the question that it all goes back to, Karen, is valuation, and "Are you getting compensated for the risk?" Again, in the bond market, with the yield that you can earn, you are very often compensated for the risk.
And what we're seeing with Ford at current levels, Ford 10-year bonds are yielding 8.5 percent. That is really reflective of a below investment grade level. Is Ford really a below investment grade credit? Well, part of that is dependent on what happens in the economy, and we don't expect a very slow economy, but if that happens, Ford's rating could go under investment grade. You're certainly compensated for that risk, relative to other high-yield bonds that are out there today.
GIBBS: Other than the cyclicals, where else do you see value?
GAFFNEY: There is value in some of the consumer industries. The consumer has been the Everready bunny, supporting the economy. Home building has held up well. Pulte Homes, for example, an investment grade home builder yielding 7.5 percent. And there's that special number that sounds like an equity return, but it's in solid bonds.
GIBBS: Jim, you seem to like some of the industrials, the basics. Where else do you see value?
PAULSEN: I like technology stocks, which is kind of, we've all forgotten about. They've actually been outperforming for about six months now with little fanfare.
I think this is going to be a business-led recovery. The consumer has been holding us up, and now we're going to switch to the business side. So I think you look at tech, I think you look at the basic industries and industrials and the manufacturing sector. The dollar's down in the last year now, and I think some trade flow has come back, and there you'll have more operating leverage for earnings.
GIBBS: Jeremy, in situations like this, where do you think you're going to see value and what sectors of the economy would perform better?
SIEGEL: Let me first pick up on something Jim said, and he's perfectly right -- there can be a long period where the market doesn't move.
But we're already down almost 50 percent from the high. If it takes 10 years to get back to where we were in March 2000, investors will average a 9-percent-a-year return (over the next seven years), even though we look at a flat (10-year) period. So it's a different situation looking peak to peak from where we are right now.
Let me also comment that I think the best quality issues (are) those where you can be sure of earnings, those that are paying dividends, because I think more and more there's an orientation towards an income-and-dividend paying stock. I think those are the ones that are going to outperform in the next leg of the bull market.
GIBBS: All right. Jeremy Siegel, that's got to be the last word, and thank you very much. Kathleen, thank you, and Jim, you too.
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