The myth of the ever-rising stock market


John Kizer



Some of the more depressing stories that one may read as he ages involve missed opportunities in the stock market. Oh, why didn’t we buy Google’s IPO? Or Amazon? If we didn’t have the foresight to buy such winning companies, shouldn’t we, at least, have had the good sense to buy the Dow Jones Industrials, or its equivalent? We are told that such an investment has gone up 25,000 times in the past 200 years, and 47.5 times since 1974. Supposedly, if we only had enough sense to put $30,000 into the Dow Jones Industrial Average (DJIA) stocks in 1974 and hold onto them, we would now have $1,425,000. Not only that, we would have enjoyed a good income from dividends for the past 44 years. That is what is implied by the change in the DJIA.

At the same time, we read stories in the financial news that most investors, at least traders, lose money in the market. I know there were academic studies showing that Lou Rukeyser’s stock picks on the old Wall Street Week were money losers. There have been similar studies of Jim Cramer’s advice more recently, showing that his stock picks perform well below the market average. Warren Buffett had a bet of a million dollars that the S&P 500 would outperform hedge fund managers over a period of 10 years. He recently won the bet, which has to make one skeptical that anyone has discovered a secret formula for stock picking. If anyone has found an algorithm for beating the market consistently, he is not telling anybody, for if he did, the algorithm would no longer work.

Getting back to the DJIA, if we had invested in those so-called blue chip stocks in 1974, instead of finding ourselves fabulously enriched, we would have found that 24 of the 30 stocks were no longer significant enough to be listed today. Many of the companies have gone bankrupt and no longer exist. These companies were just replaced on the DJIA by newer and stronger companies. If four of five of the companies have gone down in value enough to be dropped from the average, and perhaps have even gone out of business, does this not explain why the average investor, the investor with no access to inside information, seems to lose money? Even assuming the remaining 20% of the stocks increase in value by multiples, it is still a long road to investing success if 80% of the stocks lose enough value to be de-listed.

These losing stocks are replaced on the DJIA by winning stocks, which gives the illusion of an ever-rising stock market. If we had bought the DJIA market basket of stocks in 1974, we would now own Anaconda Copper, Chrysler, Swift and Co., Johns Manville, American Tobacco Co., General Foods, Inco, American Can, Bethlehem Steel, Westinghouse Electric, Eastman Kodak and General Motors, all of which have either ceased to exist or gone bankrupt. Additionally, U.S. Steel is no longer large enough to be included even in the S&P 500, let alone the DJIA, and Sears, also dropped, is nearing the end of the line. These stocks have been replaced in the DJIA by Apple, Goldman-Sachs, Nike, Visa, United Health, Cisco Systems, Pfizer, Verizon, Intel, Microsoft, Walmart, Coca-Cola, IBM and Merck. In other words, all the bad stocks have been replaced by good stocks, giving the illusion of an ever-rising stock market. This is the great surprise, that the average investor can buy and hold blue chip stocks, the best stocks in the country, and yet still lose money in the long haul. It’s because the DJIA, along with every other index, has only risen meteorically because the bad stocks have continually been replaced by the good stocks, giving the illusion of an ever-rising stock market.

I know there’s a study which exists which purports to show the de-listed stocks perform better than the stocks added to the index. To that I will simply say to the reader that he can read the previous paragraph and see that is obviously not the case in the long run.

If one does not buy and hold but tries to be a trader, then transaction costs, broker’s fees and the like, come into play. They can be significant with enough trades. Another possible explanation of the poor performance of the average investor’s portfolio is simple market economics. Demand is what causes the price of a stock to rise. As the prices rise, people are fearful of missing a windfall, so unsophisticated investors flood into the market, buying at the highest prices. When there are no more potential buyers, the price must inevitably decline and the small, unsophisticated investors who came into the market at the top are the ones who are hurt.

One, of course, must do something with one’s money. For the average investor, buying a market fund might be the safest way to go, though what has worked pretty well of late is always to bet on Bob Baffert, but maybe I just feel that way because all we old white-haired guys need to stick together.

John Kizer

John Kizer has been published by the Foundation for Economic Education, and some of his submissions have been included in The Encyclopedia of Freedom.

John Kizer has been published by the Foundation for Economic Education, and some of his submissions have been included in The Encyclopedia of Freedom.

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