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Too Much Pessimism?

As you no doubt know, this has been a time of considerable volatility in global financial markets. At Grand Wealth Management, we won't pretend to know how this downturn will play out or how it will stack up against ones we've seen before. But we’d like to offer an historical perspective on risk and return that we hope will be useful.

We believe that risk and return are related, and that over the long term, higher returns are the reward for taking greater levels of market risk. But risk doesn’t get rewarded every year – that’s the nature of risk – and it can sometimes go unrewarded for a number of years. The table below illustrates this point with three sets of returns for the S&P 500 index and Treasury bills, the "riskless" asset.


S&P 500 Index

One-Month T-Bill










For the 17 years from 1965 through 1981, the annual returns for both stocks and T-bills were about 6%. In 1981, financial markets were under stress, volatility was high, and people were in a funk about equity markets, since risk hadn't been rewarded for a long time. One financial magazine, in fact, featured a cover story on "The Death of Equities." The pessimism was unwarranted, and there was no sensible risk/return story to explain why stocks should have a zero risk premium. There was no valid reason to get out of equities.

At the end of 1981, no one would have predicted that the next 18 years would be possibly the best 18-year period ever for US stocks. But surprisingly, that’s how things turned out: from 1982 to 1999, the S&P 500 had an 18% annual return, compared to 6% garnered by Treasury bills. As a result, in a reversal of the gloom and doom of 1981, people generally became overly optimistic about equities. We think of S&P 500 stocks as having about a 10% cost of capital. When investors get 18% a year for S&P 500 stocks, they should enjoy it, but not count on it into the future.

The final line in the above table displays results for the current millennium, a period of nine years so far. The return on the S&P 500 is negative. Again, pessimism is thriving – and again, we suspect, it’s overblown. We’re not making a forecast here, but we feel that a zero return for stocks is not the market-clearing expectation. We feel that clients should maintain their normal commitment to equities and remain in a position to capture the returns that generally occur early in a market recovery.

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