Stocks for the Long Run: Historical Facts and Statistical Fallacies

The doctrine of “Stocks for the Long Run” has been the cornerstone of strategic asset allocation portfolios for many decades. The catalysts of this phenomenon were the contemporaneous onset of the 1980-2000 bull market, one of the strongest in history, and the emergence of modern financial theories like Modern Portfolio Theory and The Efficient Market Hypothesis. Longer historical evidence has also been used to make the case that equities invariably outperform bonds and cash over sufficiently long time horizons. However, the disappointing performance of stocks over the past decade, culminating in the 2008 market crash, has caught many investors by surprise and raised doubts about the validity of these commonly accepted investment principles.In this article we take a critical look at both the theoretical principles and historical evidence to make the case that "this time is different", i.e. that the "Stocks for the Long Run" principle may not apply for many years to come. And yet, "this time is not different" since the current market regime has occurred several times in the past, although history's lessons have been either disregarded and or forgotten. This has been largely due to a combination of incorrect application of the assumptions behind Modern Portfolio Theory and to an incorrect use of statistics, a problem first noted by Paul Samuelson many years ago.It can be argued that the main risks facing investors in this "new normal" markets are a) failure to learn from history, and b) failure to understand the limitations of Modern Portfolio Theory. The challenges are not only technical, since moving away from traditional asset allocation policies and into policies more suitable for the current market cycle may entail significant career risk.