David Booth

IFA's Quote of the Week - 41 (David G. Booth)

David Booth


"You’ve already paid for the risk, so it might be good to stick around for the expected return."

-David G. Booth, Chief Executive Officer, Dimensional Fund Advisors




 Are We There Yet?

As we embark on the busiest travel time of the year, it seems all too fitting to question if we are there yet. The “there” to which we now refer is not the comforting destination where we will enjoy Thanksgiving dinner in the company of those we love. Right now, the destination we currently seek so desperately is a bottom for the equity markets.

Freshly haunted by October lows, November looked like it would give investors even less to be thankful for. Indeed, confirmation of an economy in recession, stock prices hitting levels not seen since Bill Clinton first took office, jet-setting auto executives arriving hat in hand begging for financial jump-starts, a $20 billion dollar bailout for Citigroup, a defense of last month’s $700 billion TARP plan, a newly added $800 billion TALF plan for consumers, and a 17% one-year decline in home values have certainly generated some queasy stomachs long before the turkey even hits the table.

Certainly, we have suffered some dark moments in the last 13 months, the darkest of which have unfolded in just the last six weeks. Credit markets are taking their own (not-so-sweet) time to ease and volatility has been higher than we have seen. Frustration with the markets finds more than a handful of investors asking if it’s time to step out or step up.

In a not-so-commonplace video appearance, Dimensional Fund Advisors’ CEO David G. Booth asks and answers the question that so many investors are asking: Why Stick Around In A Tough Market?

“This is a good time to invest in equities, and it is a good time to stick with your asset mix,” says Booth. He advises that his “return to normal” outlook has its foundation in three specific measures that include:

1) Valuation: Booth observes that dividend yields currently exceed Treasury yields, leading him to conclude that valuations are low.

2) Market Equilibrium: As the founder of DFA, Booth and his compatriots foster an equilibrium view of markets that is deeply rooted in the principles of market efficiency. Booth states that “market efficiency keeps us disciplined in these tough times.” He explains that huge volume of trading means that there are both sellers and buyers. Those who are now buyers of equities do so because all of the information that they possess tells them that the current price is a fair price. This is the way markets work. Our markets involve a voluntary exchange.

Booth elaborates on this concept of the voluntary exchange principle, stating that the market may be a more opportunistic place now as there may be more involuntary sellers than voluntary buyers. This can drive prices down to very attractive levels. He cites that the de-leveraging that must occur could be more favorable to buyers than to sellers who have to let go of their shares at low prices.

Distress selling can create opportunities for long-term investors who are able to provide liquidity when sellers desperately need it. Recently, we have seen some evidence of this sort of distress selling. Markets which seem to hold their own for nearly the duration of the trading day have dropped off sharply in just the last few minutes of trading. Sunil Wahal, finance professor and research associate for DFA, describes this circumstance of unprecedented volatility as an opportunity for long-term investors to provide liquidity to pressured sellers. Wahal’s paper titled “The Effects of Recent Market Volatility on Trading” concludes that those with enough risk capital and risk tolerance to provide liquidity can expect to eventually earn a return for it.

3) Intuition: Booth cites that periods of stress overlook optimism for the long-term perspective. Booth adds, “Governments can have an impact. Let’s hope it’s positive this time.”

Booth is far from a lone long-term optimist. In the wake of the economic disaster that has unfolded before us like a train-wreck in slow-motion, many long-term investors have weighed in on the long-term outlook for equities. In fact, America’s most-famed investor, Warren Buffett is cashing in his U.S. government bonds and gobbling up stocks.

In an October 17, 2008 Op-ed piece for the New York Times titled “Buy American, I am”, Buffett states:

“Let me be clear on one point: I can’t predict the short-term movements of the stock market. I haven’t the faintest idea as to whether stocks will be higher or lower a month — or a year — from now. What is likely, however, is that the market will move higher, perhaps substantially so, well before either sentiment or the economy turns up. So if you wait for the robins, spring will be over.”

“Fear is now widespread, gripping even seasoned investors. To be sure, investors are right to be wary of highly leveraged entities or businesses in weak competitive positions. But fears regarding the long-term prosperity of the nation’s many sound companies make no sense. These businesses will indeed suffer earnings hiccups, as they always have. But most major companies will be setting new profit records 5, 10 and 20 years from now,” Buffett adds.

IFA makes no attempt to time markets. Rather, IFA lets history do the talking. Stock market history continues to reveal that no one can persistently pick the times to be in the markets for the upturns and be out of the markets during the downturns. Additionally, the increased volatility virtually ensures that those who capitulate will miss out on the kind of returns that were handed out when the markets, just this week, staged their biggest 2-day gain in more than two decades.

The inability to predict the time to exit the markets to avoid losses and the time to re-enter the markets to capture gains ensures that those who wish to earn the long-term returns of the equity markets must sit through the discomfort in order to reap the rewards. Buffett provides a sound (and fun) analogy:

“Equities will almost certainly outperform cash over the next decade, probably by a substantial degree. Those investors who cling now to cash are betting they can efficiently time their move away from it later. In waiting for the comfort of good news, they are ignoring Wayne Gretzky’s advice: “I skate to where the puck is going to be, not to where it has been.”

Certainly, Buffett’s rationale provides temperance and guidance for long-term investors. Buffett’s long-term optimism is rooted in the historical long-term prosperity of businesses that will earn profits over time. This is precisely why a globally diversified portfolio is such a prudent investment path. Diversification not only ensures that a portfolio’s holdings will not be annihilated in steep market downturns, but it also ensures that the portfolio will have full benefit of the global market upturn.

Market declines may feel interminable when we are in the thick of them. They are ravaging and they are brutal. But, history does show that the best way to survive them is to buy and hold as much risk as your personal situation can manage and keep your eyes fixed on the long-term expected return which remains about the same as it was before any of us ever heard about bailouts, TARP, TALF, or had to change the meaning of “Are we there yet?”

As indexers, we may still ask the question, but we can continue to expect our long-term returns, whatever the answer might be.