The Buckingham Report

With the Dow Jones Industrial Average again piercing the 12,000 mark in today’s trading, it seems a perfect time to remind readers that the road to long-term investment success has always been filled with many short-term potholes. Consider that the Dow has hit a record high even though in the last month North Korea conducted a nuclear test, a small plane carrying New York Yankee’s pitcher Cory Lidle and his flight instructor crashed into a Manhattan skyscraper, the options backdating scandal snared several additional high-profile executives and the September business-conditions index published by the Philadelphia branch of the Federal Reserve showed that manufacturing activity in that region was contracting for the first time in three years.

And we can’t forget that two months ago police in the United Kingdom took 21 people into custody over an alleged plot to blow up several trans-Atlantic flights with explosives smuggled in hand luggage or that three months ago hostilities broke out between Israel and Hezbollah, sparking fears that other Middle Eastern countries would become involved in the conflict. Stocks have also moved up despite September and October being two of the worst performing months of the year, historically speaking.

While Ibbotson Associates tells us that equities have returned 10% to 12% on average over the past 80 years, we also know that the majority of investors are unable to achieve this level of performance. Why is that? Because they trade far too often, moving in and out of the market in reaction to media headlines, chasing yesterday’s stars while dumping tomorrow’s potential winners. Don’t believe me? The Wall Street Journal recently cited research from mutual fund rating agency Morningstar that said that over the past 10 years, owners of diversified U.S. stock funds collected 7.3% a year, less than their fund’s average 8.8% published return.1

That same article cited a University of Michigan academic study by Ilia Dichev that examined the long-run returns following all capital flows over the entire history of available stock returns and across the United States and many foreign countries. The study found that aggregate dollar-weighted returns are systematically and considerably lower than buy-and-hold returns. The annual return differential is 1.3 percent for the NYSE/AMEX market between 1926 and 2002, 5.3 percent for the more volatile Nasdaq between 1973 and 2002, and an average of 1.5 percent for 19 major stock markets around the world between 1973 and 2004. Mr. Dichev concluded, "The results provide comprehensive evidence that stock investors' actual returns are considerably lower than those from passive holdings and very different from widely published and studied security returns."
 
Sure, there will always be some who successfully time the market as it certainly would have been nice to have been on the sidelines for the big downturn during 2002 and then fully invested after equities bottomed in October of that year. And we recognize that many will continue to frantically move in and out of stocks after getting signals from price charts while others will put their faith in pundits who play on emotions like fear and greed with predictions that the market will soar over the next three years only to crash sometime after 2010 as baby boomers cash in their stocks to fund their retirements, or that the crash will come six years later when boomers turn 70 and start to withdraw from their 401K and other pension plans.

Conceding that we do not know what the future will hold, we continue to believe that a slow and steady, buy-and-hold-but-don’t-forget strategy that pays attention to the financial fundamentals of the companies in which one invests will produce the best returns over time. After all, such an approach generally yields more undervalued shares to buy when stocks are low, affords greater opportunity to sell fairly-valued companies when share prices have advanced and generates fewer buy candidates when the markets have skyrocketed.

Despite the historical evidence that suggests long-term investing is the way to go, we understand that there will always be scary things to worry about and our faith in equities will constantly be put to the test. Certainly, we can’t dismiss every concern and there undoubtedly will be more downturns in our future, but it is helpful to remember advice offered by legendary investor Peter Lynch and our founder Al Frank.

Here is what the former Portfolio Manager of the Fidelity Magellan Fund said in the wake of the tragic events of September 11, 2001: “Despite nine recessions, three wars, two Presidents shot (one died and one survived), one President resigned, one impeached, and the Cuban Missile Crisis, stocks have been a great place to be. The United States historically has had a perfect record when it comes to rebounding from the most difficult times. With those nine recessions, we’ve had nine recoveries. Since World War II, corporate earnings are up 63 fold and the stock market is up 71 fold. Corporate profits have grown over 9 percent annually despite the down years.”2

Al’s words of wisdom, written on October 1, 2001, were as follows: “I cannot live in fear of the next terrorist attack (if you make yourselves sheep the wolves will eat you) or of the bottom dropping out of the market. My attitude is not a question of being optimistic or indifferent, it is based on history and probability as I see it. There will probably be more terrorist attacks, and although many of them will be thwarted, some will happen. Even so, we will have to adjust and live as normally as possible (albeit a new norm). The stock markets are part of the fabric of our free enterprise system. They will be around and functioning for a long time.”3

And speaking of September 11, if we somehow had advance knowledge of the terrorist attacks, the natural reaction might have been to liquidate our equity portfolios, but our real-world experience illustrates that unless one's timing was superb this would not have been the right move. Yes, the stock markets did tumble when trading finally resumed on September 17, and while our managed accounts had been up 6 percent on average for the year through September 10, we did suffer sharp setbacks. However, those short-term losses were overcome and then some by the end of 2001. Despite subsequent anthrax scares and the crash of another jumbo jet in New York, our managed accounts finished the traumatic 2001 year with gains of 25 percent on average!*

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Opinions expressed are those of John Buckingham, which are subject to change without notice and are not intended to be a forecast of future events, a guarantee of future results, nor investment advice. The information contained herein is believed to be reliable. However, such information has not been verified by us and we do not make any representations as to its accuracy or completeness.

Past performance may not be indicative of future results. Therefore, you should not assume that the future performance of any specific investment or investment strategy will be profitable or equal to corresponding past performance levels. In every investment strategy there is a possibility of loss.

Al Frank Asset Management (Al Frank) is an Investment Adviser, registered with the Securities & Exchange Commission, is editor of The Prudent Speculator (TPS) newsletter, editor and publisher of The Prudent Speculator TechValue Report (TVR) newsletter, and is the Investment Adviser to two value-oriented no-load proprietary mutual funds and individually managed client accounts.

Al Frank adheres to the same investment principles and philosophies in managing individual client accounts, its proprietary mutual funds and in the information that appears in its two investment advisory newsletters, which is seeking long-term growth of capital by owning a diversified portfolio of securities that are believed to be undervalued and holding them for their long-term potential capital appreciation. Portfolios may contain securities that are no longer recommended and therefore may not be part of a client’s account.

*Al Frank’s managed account performance is an average of our managed account composites. Results for 2001 are for the twelve-month period ended December 31, 2001. Performance may vary by account as client accounts are individually managed.  Al Frank has managed client accounts throughout numerous market environments.

Performance results are calculated by actual total return, and are net of advisory fees paid by clients, trading costs and include the reinvestment of dividends and interest and the effects of margin leverage and margin interest charges.

The NYSE Composite Index measures all common stocks listed on the New York Stock Exchange. The AMEX has now merged with the Nasdaq. It was known as the "curb exchange" until 1921. It used to be a strong competitor to the New York Stock Exchange, but that role has since been filled by the Nasdaq. Today, almost all trading on the AMEX is in small-cap stocks, exchange-traded funds and derivatives. The Nasdaq  Composite Index measures all Nasdaq  domestic and non-U.S. based common stocks listed on the Nasdaq  Stock Market. You cannot invest directly in an index
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About Al Frank Asset Management

Al Frank Asset Management, Inc. is committed to assisting our customers build wealth. We are a leading resource for value-based investor information in the financial community, where we combine our simple, proven philosophy of buying under valued securities for their long-term appreciation with our experience, hard work, and intensive research to give you actionable investment information that can be used on a daily basis.

For information on separate account management, please call us toll free at (888) 994-6837. Or, visit us at www.alfrank.com.

1 The Wall Street Journal October 18, 2006, Coming Up Short page D1.
2 Peter Lynch Market Commentary, September 20, 2001
3 Al Frank’s The Prudent Speculator, October 1, 2001