Rip Van Winkle, revisited

Here's a link to recent commentary entitled "Still Bullish," from one of the most insightful economists we know, Brian Wesbury.

In it, he proposes a mental exercise, asking readers to imagine that they had gone to sleep on October 09, 2007 (when the major US stock indexes were making record highs, but just before they began their decline towards what became one of the deepest and most gut-wrenching bear markets in history), and just woke up this week.  In this exercise, he explains, our modern-day Rip Van Winkle would have slept through 67 and 1/2 months, nearly six years.  

He then asks readers whether, knowing where equities are today and where they were at that time, they would have chosen to buy equities or not before this long nap.  If the answer had been "buy," then even though the economy suffered a violent recession and the markets were ravaged in the interim, Rip would have awakened this week to find the Dow Jones Industrial Average 8.4% higher than when he started his nap back in October of 2007. 

We believe investors should carefully consider the implications of Mr. Wesbury's article, and the data he provides to support his arguments.  In fact, we used the very same Rip Van Winkle analogy in two blog posts in the past, both of which are worth revisiting today:
In those articles, we pointed out that this analogy is helpful, but only to a point.  We obviously do not advocate simply ignoring one's investments under the mistaken belief that things "always turn out for the best."  Many who have not read Washington Irving's actual tale do not realize that his Rip Van Winkle was not exactly a sympathetic character, but instead was one described as having an "insuperable aversion to all kinds of labor," and one who would rather "starve on a penny than work for a pound."

We also don't advocate the idea that investors are best served if they just "own the market" rather than spending energy evaluating individual companies to find superior destinations for investment capital.  While Rip would have been better off had he bought all the companies in the S&P 500 before his nap than if he had left that money in cash, he would have been even better off if he had been able to buy the shares of a smaller number of truly exceptional companies instead.  Note that in the "nap interval" selected by Mr. Wesbury, the thirty-name Dow Jones Industrial Average outperformed the 500-name S&P index by a fairly wide margin.

However, the main point of the Rip Van Winkle exercise is to highlight the fact that for the vast majority of investors, investing in equities must be a long-term decision, appropriate for assets that one can afford to leave invested for many years.  When that is the case, then investors can afford to take the longer view, and avoid over-reacting and potentially causing self-inflicted wounds during the intervening period.  Like the hypothetical investments of Rip Van Winkle in the illustration of Mr. Wesbury or in our blog posts above, the markets can go through all kinds of gyrations in the intervening years, but none of that matters if your investments are worth more in the long run than they would have been worth had you made a different choice.

This is a very important point to keep in mind during times of turmoil.