If you don’t ask why, you can believe anything
I am an unrepentant skeptic. If you want to get my attention, make a claim about a factual matter without providing any proof or data to back up your claim. Even worse, provide bad or incomplete data.
The practice of skepticism has a long and shining history, starting with the Greek philosophers and running through such modern luminaries as Albert Einstein and Michael Shermer.
At its core, skepticism is the art of asking why. Someone makes a claim or observation, you ask why. They give you a first answer to which you again ask why.
The process of drilling down into the issue, of peeling back the layers of the onion, can eventually lead to truth. Or, equally as often, it will uncover lack of truth.
I’d like to illustrate the concept with reference to a magazine article I read last night. A national news weekly gave the advice that, in order to beat inflation, you should buy stocks. They used three periods of time to illustrate their point: 1926 to 2004, 1987 to 1990, and 1979 to 1981.
During these selected periods, stocks paid significantly more than the rate of inflation. The investment skeptic will ask why and look more deeply into the question.
First, we should notice the odd selection of time periods. A 78-year period, a three-year period and a two-year period. Hmmm. What about five-, 10- or 20-year periods? I don’t have 78 years to wait, and two- to three-year periods are too short a horizon for stocks.
On a hunch, I looked through the data myself. It wasn’t hard to find a few periods where stocks did not keep up with inflation. In fact, they all but leap out of the database.
For the five years from January 1973 to January 1978, stocks paid a total annual return of minus 4.5 percent while the annual inflation rate averaged 8 percent. Stocks trailed inflation by a compounded 46 percent over only five years. The spending power of stock portfolios was cut almost in half.
What about periods in which stocks made good money but inflation was high enough to wipe out returns? Since you asked, the five years following January 1945 saw annualized stock returns of 5.2 percent with annual inflation of 7.4 percent. I could go on and on.
The point here is that with sloppy or careless examination of the data, one can find select periods of time that support almost any conclusion.
As we continue to ask why, we begin to find that stocks tend to do well not merely when inflation is high or low, but when inflation is moving from high to low. Stocks move higher more often when inflation has drifted lower than when inflation is stable.
Since 1900, whenever inflation in one five-year period changes a small amount from the previous five-year period - what I call stable inflation - stocks beat inflation two-thirds of the time.
This is true whether inflation is high or low. In times when the rate of inflation declines significantly across those sequential five-year periods, stocks beat inflation an astounding 98 percent of the time.
Rick Ashburn manages investments for private clients. Write to him at firstname.lastname@example.org or 7777 Fay Ave., Suite 230, La Jolla, 92037.