OShaughnessy - Predicting the markets of tomorrow: a contrarian investment strategy for the next twenty years

In March of 2000, the S&P 500 marked its highest twenty-year real rate of return in over one hundred years. U.S. intermediate-and long-term government bonds reached the same high-water mark a year and a half later in September 2001. On the way to this summit, investors created one of the largest bubbles in history for trendy, new-era stocks and lived by the mantra that it was different this time. Near the end of this one-hundred-year flood in financial markets, many respected advisors were strongly recommending that investors allocate the bulk of their assets to large capitalization growth and technology stocks. Enthusiastic investors bid profitless companies to unprecedented valuations on little more than the ever-present hope that it really was different this time! It was widely accepted that a new era had dawned on Wall Street, requiring investors to throw out the old valuation rules and start using new metrics to price stocks according to their true value.

Simultaneously, the shares of small-and mid-cap stocks, as well as large capitalization value stocks, lagged both the S&P 500 and large capitalization growth stocks by the widest margins seen in the last seventy-seven years. What virtually every investor of the era knew through their experience in the market was that only a handful of the right stockslarge-cap growth or technology issues, or for the more conservative, an index fund mirroring the S&P 500would be the ticket to continued double-digit growth for the foreseeable future.

Its time for investors to be reeducated.

I believe that what investors have learned over the past twenty years has clouded their expectations about what returns they might expect over the next twenty years, particularly concerning what types of stocks and bonds will offer the highest returns. Careful analysis of long-term data shows us that financial markets have reached such great heights on several occasions in the past century. It is very instructive to look at what happened after each of these zeniths. Close examination of one hundred years of market data allows us to predict what might be in store over the next twenty years. Studying the markets of yesterday can help us understand the markets of tomorrow.

I hope that this book will be a call to action for investors who dont want to be left behind, and to all investors who want to reap the highest returns that the market might offer in the coming two decades.

The stakes could hardly be higher. We are facing a triple threat to our investment health: the future of Social Security is cloudy, corporate pension plans are massively underfunded, and many baby boomers failure to save for retirement has left them frantically scrambling to find a way to a secure retirement. And despite Americans fascination with the stock market over the past few decades, most are still financially illiterate. An April 27, 2005, article in the New York Times reported on a survey showing that the typical American knows virtually nothing about the economy or about how the stock market works. The article notes that about half of American adults did not know that if they kept their money at home, in cash, they were at greater risk of losing ground to inflation than if they invested elsewhere. Whats more, the average American gives very little thought to what he or she will need for retirement. According to a survey by the Principal Financial Group Inc., just 42 percent of American workers have done calculations to figure out if they are saving enough for retirement.

In all three of my previous books I have sought to understand why certain stocks go up while others decline. In What Works on Wall Street, I found that Wall Street consistently and methodically rewards securities with certain attributes just as surely as it punishes those with others. But it was only by looking at very long periods of datafifty-two years for What Works on Wall Street that this proved to be true. If you look at very short periods of time, what you see is meaningless noise. One five-year period would show small stocks performing well, another would show large-cap growth stocks on fire, a third might recommend value. When looking at the fullness of time, however, you see that certain types of stocks perform vastly better than othersand that there was a good reason for their superior performance.