Records

Far too many investors have high expectations, and have been spoiled by the bullish 1990s. It is absolutely amazing to see how far we have advanced, and how many companies simply did not exist prior to 1990. No QQQ, no OEX, no YHOO, and even no Starbucks. Let's take a look at the SPX historical chart, which is the best long term Index to consider, and see what really happened to the market from 1970-2004.

Looking at the chart above, you can see that from 1970 to 1983, the market was relatively flat compared to the 90s. Overall, the 80's were much better as the SPX moved from 105 to 353. It's actually amazing to see the 1987 spike which resulted in a subsequent crash.  I say amazing because, the spike does not look nearly as dramatic as the spike that followed in 90s. You can see that the market went through an amazing transformation for the past 20 years. Is it any wonder the market crashed in 2000?

Over the years I have looked at thousands of charts, studying volatility and its effect on individual stocks. Now it is one thing to study individual stocks, and another to draw conclusions on Indices. Unfortunately, we just do not have enough information on Indices. Accordingly, although my comments are based on my study of individual stocks, my hunch tells me that Indices will react in ways similar to the ways individual stocks do.

If you don't think that the market was a casino in the 1990's, then I don't know what else to call it. Tech, internet, telecommunications, all contributed to an amazing boom in the 90's. One can say that the 80s were good, but the 90s were unbelievable. The two most important factors that jump to my mind are:

1 Beginning in 1990, the number of companies in the market has more than doubled.
2 In the 90's, the market went through the biggest stock appreciation in its history. 

It is important to notice that the most recent stock market crash, beginning in the year 2000, did the most damage to volatile stocks. The NASDAQ corrected from 5132 to 1108, far stronger than the correction of the S&P.

So what do I expect from the market now?
Whether the market is expensive or not is really not the issue, as markets have been known to stay expensive for decades.  I do, however, expect two mathematical concepts to materialize.

1.  Regression to the mean.
2.  Volatility to beget volatility.

Following the market corrections of years 2000-2002, the market rebounded sharply.  Regression to the mean dictates that the market at some point will retract to the downside. The manner in which the retraction occurs will dictate my ROI expectation.  If the market retracts sharply in a crash mode, then we can all expect to continue see high returns, as the market will surely rebound sharply again.  However, if the market corrects itself slowly, then we are all in for a lower overall ROI for the current decade.

I expect that volatile stocks will continue to be the most vulnerable group, and conservative stocks will only decline modestly on any market sell off.  I also think that the GetFolio.com "narrowing of the Indices X scores" will serve as a buying opportunity each time the market corrects itself, assuming you diversify widely and control your volatility.