If you want to know why, for most people, their house is a better investment than stocks, read David Stockman\u2019s New York Times<\/b>\u00a0jeremiad \u201cSundown in America.\u201d\u00a0 It is alarming articles like this that convince investors to avoid buying stocks until they have climbed a lot and look \u201csafe\u201d \u2014 and then to sell them during recessions after they have plunged in price. The result is terrible long term performance.\u00a0 Call it the \u201cliquidity trap.\u201d\u00a0 People don\u2019t sell their home during a recession because it is illiquid and\u00a0they need a place to live.\u00a0 Stocks, by contrast, are easy to buy near the top and sell at the bottom.<\/p>\n
Stockman\u2019s article is full of mistakes.\u00a0 For example, \u201cthe Fed\u2019s unforgiveable bailout of the hedge fund Long-Term Capital Management\u201d never happened.\u00a0 Wall Street firms, not<\/b> the Fed, provided liquidity to unwind the fund, and the original investors lost all their money. Another mistake: he forgets\u00a0that debt\/GDP accelerated in the 1980s because inflation and therefore nominal GDP growth\u2014declined.\u00a0 Obviously disinflation was positive, not negative. But Stockman\u2019s scary sundown story is instructive nonetheless because its omissions and distortions illustrate five important lessons for long-term investors:<\/p>\n
The \u201cGood Old Days\u201d sucked too<\/b>.\u00a0 Stockman portrays the century before 1980 as saner and safer because debt \/ GDP averaged just 160%, versus 350% now.\u00a0 Alas, according to the National Bureau of Economic Research, there were 24 \u201ccontractions\u201d (recessions or depressions) during that century, so the\u00a0economy was contracting a third of the time<\/b>. Believe me, the \u201cgood old days\u201d did not seem so good to investors during the financial panics and wars of 1893, 1907, 1914, 1921, 1929, 1937, 1945, 1950, 1970, 1974, and 1981.<\/p>\n
Stocks Can Survive Government Mismanagement<\/b>.\u00a0 According to Stockman the \u201csundown\u201d started in 1982, when debt growth accelerated and the U.S. fell into a hopeless abyss of crony capitalism.\u00a0\u00a0Nevertheless since 1982 stock prices have climbed 1,302% (8.9% CAGR) while paying an average dividend yield of 2.6%.\u00a0 The 2013 dividend represents a 31% yield on the March 31, 1982 price.\u00a0 This is a disaster you can retire on.<\/p>\n
S&P Is Not GDP<\/b>\u00a0\u00a0 Stockman claims today\u2019s \u201cbubble\u201d was inflated by Fed liquidity \u201crather than real economic gains.\u201d\u00a0 Wrong; earnings have climbed\u00a0as much as stock prices since 2009, as detailed in our latest post.\u00a0 More broadly, the woes of the \u201cmain street economy\u201d are not strictly germane to equity investors, who mainly own giant multinationals which are faring much better than small business because:\u00a0 A)\u00a0 instead of being hurt by the Internet, giant firms build, own, and operate the web;\u00a0 B) they have high exposure to fast-growing emerging markets;\u00a0 C) they have more capital equipment per worker, and therefore\u00a0higher labor productivity and faster productivity growth; D) they are better able to fight through Washington\u2019s reams of red tape; E)\u00a0 they have excess capital and cash flow, permitting share buy-backs and acquisitions.\u00a0 These factors account for strong recent profit growth despite a weak U.S. economy.<\/p>\n
The Financial Economy is not the Real Economy<\/b>\u00a0 Stockman gleefully details the misadventures of Wall Street without mentioning the extraordinary achievements of other industries \u2013 the Internet, the fracking revolution, the railroad renaissance, biotech\u2019s transformation of healthcare and agriculture, or the rise of potent consumer franchises such as Wal-Mart, Costco, McDonalds, Nike, Starbucks, Panerra, Amazon, and\u00a0Wynn Resorts, to name a few.<\/p>\n
Known Risks Are Less Dangerous.<\/b>\u00a0 After a tedious tour of five decades of financial folly, Stockman gets to his main point: \u201cwhen the Fed\u2026.even hints at shrinking its balance sheet, it will elicit a tidal wave of sell orders\u201d in the bond market.\u00a0\u00a0 In contrast to the housing bubble, everyone\u2014even the Fed\u2014knows this is a risk and will behave accordingly.\u00a0 As noted in my last post, the stock market is not assuming bond yields stay at 2% forever<\/b>.\u00a0 In fact a bond bear market could scare some money into equities, which are more reasonably valued than bonds.<\/p>\n
Macro Policy Is Improving<\/b><\/p>\n
Stockman studiously ignores the good news. Belying Keynesian orthodoxy, GDP is accelerating despite the tax hikes and sequester because House Republicans have put Obamanomics on hold.\u00a0 Obama\u2019s warnings that modest spending cuts would spell disaster look ridiculous to workers in the real world beyond the Beltway who have endured five years of austerity. \u00a0Washington is finally considering policies that would actually boost growth, such as immigration reform, entitlement reform, and tax reform. \u00a0Eventually Obamacare will be reformed because it is unworkable and unpopular.<\/p>\n
Bottom Line<\/b><\/p>\n
Buy and hold is difficult and unfashionable, but it works.\u00a0 It works even better if you use dollar cost averaging and avoid dumb fads, such as energy stocks in 1979, biotech stocks in the early 1990s, tech stocks in the late 1990s, and housing stocks in 2007.\u00a0 The dumb fad to avoid now, after stocks have gone nowhere since 2000 and look, at worst, reasonably valued while economic growth and economic policies are improving, is\u00a0Stockman’s Scary Sundown.<\/p>\n
Copyright 2013 Thomas Doerflinger.\u00a0 All Rights Reserved.<\/p>\n","protected":false},"excerpt":{"rendered":"
If you want to know why, for most people, their house is a better investment than stocks, read David Stockman\u2019s New York Times\u00a0jeremiad \u201cSundown in America.\u201d\u00a0 It is alarming articles like this that convince investors to avoid buying stocks until … Continue reading