Monday, September 5, 2011

Are Stocks Still a Good Investment?

The latest jobs report, on Friday, which revealed no net job growth, confirms what a lot of people suspected: that the economy is stalled out. The prospects for the future are guarded, at best. Businesses don't want to hire. Consumers don't want to spend. Political pressure from the right prevents further large scale governmental intervention. Except possibly by the Fed, and its options don't look appealing. The most it can hope for is that further money printing might puff up the financial markets and create a "wealth effect" to spur spending by the rich. But Tiffany, Hermes and Louis Vuitton don't employ that many people in America's heartland, so more money for the rich won't do much to revive the overall economy.

Are stocks still a good investment? Whatever the Fed does, it will have only a short run effect. QE2, announced a year ago, is already dissipating. If the Fed does QE3, it will likely have little or no impact beyond the months the Fed is running the money printing presses. After that, we'll probably stagnate again.

Japan's experience suggests pessimism. In the late 1980s, Japan had a real estate and stock market bubble that, if you can believe it, was more extreme than America's recent bubbles. Real estate prices went so high that people were taking out 100 year mortgages to pay for their homes. When it comes to encumbering future generations, that takes the cake.

The Nikkei 225 average peaked at 38,916 on December 29, 1989, and then popped a la Dow Jones Industrial Average circa 1929-1933. It eventually dropped below 8,000 (not a typo; we're talking a belly flop of more than 80%), and now putters around the 8800 level. Adjusted for inflation, that means the Nikkei 225 is still almost 80% below its all time peak. A minus 80% return for over 21 years is, no matter how you look at it, pretty stinky.

An example closer to home of the deleterious effects of an asset bubble is the Nasdaq stock market. The Nasdaq index peaked at 5,048.62 March 10, 2000. Since then it has dropped as much as 70% or so. It has never recovered more than half its peak value, after adjustment for inflation. Today, it trades around 35% of its 2000 peak, on an inflation-adjusted basis. A minus 65% return for 11 years is also pretty stinky.

The performance of other U.S. indexes isn't as bad as the Nasdaq. After adjustment for inflation, the S&P 500 trades around 54% of its all time peak on March 24, 2000 of 1527.46. The Dow Jones Industrial Average trades around 70% of its all time peak on April 11, 2000 of 11,287.08, after adjustment for inflation. Nevertheless, all of the major indexes are significant losers over the past 11 years.

Japan's government did a lot of the things the U.S. government has been doing since the 2008 financial crisis--deficit spending, money printing, zero interest rates, keeping downward pressure on its currency. None of it revived the economic locomotive that was the Japanese economy during the 1970s and 80s (although these measures may have prevented things from getting worse). The Japanese government protected jobs by keeping zombie corporations and zombie banks on life support. After ten or more years, the Japanese government began to eliminate zombie businesses. By the time it was done, however, the Japanese consumer was thoroughly beaten down, and China and other Asian nations had muscled into the export markets that Japan had previously dominated. While Japan remains a wealthy nation with a large export sector, it has limited potential for growth. Its stock market may not ever, in a time relevant to anyone reading this blog, recover its luster.

What of U.S. stocks? Economic growth is one factor crucial to future stock values--growth in America and growth overseas where U.S. corporations have markets. At this juncture, that's anyone's guess. Add to the mix downward pressure from Baby Boomers (in Europe and Aisa, as well as America) selling stocks to finance their retirements, and stocks appear to be a speculative bet. It is true that, after the 1929-33 crash, stocks recovered to about 50% of their pre-crash value after 21 years. But the enormous stimulus of wartime spending for the Second World War, plus the fact that America had most of the world's functioning industrial base immediately after the war, account to a large degree for that partial recovery.

Or course, not being in stocks means missing market upswings. If you buy today, you aren't paying the peak prices of 2000, but today's somewhat beaten down prices. Your basis is lower and future returns may be positive. It makes sense to have part of your portfolio in stocks. But don't think in terms of maximizing upside potential--that necessarily means maximizing exposure to downside risk. The past 21 years teach that risk of loss isn't a fictional bogeyman from fairy tales. You will lose money from time to time if you invest in stocks. But you may make some or all of it back, and perhaps enjoy net gains.

Put a good chunk of your portfolio in bonds and/or CDs. These investments add stability, and a bit of income. Reinvest the income (along with any dividends you get from your stocks) to get the benefit of compounding (for more on compounding, see

A portfolio invested 60% in stocks and 40% in bonds has historically performed pretty well in capturing most stock market gains while providing greater stability in value than stocks alone. As you get older, avoiding loss becomes more important than securing gains. So shifting as you age to a stocks/bonds and CDs ratio of 50-50, 40-60 and later 30-70 is prudent. None of this means you will necessarily make money. You may lose it. But you might lose more if you invest only in fixed income and money market instruments. Asset values, artificially inflated over the past 15 years by inordinate amounts of easy credit from central banks, have been deflating and may continue deflating for a long time. The only way to predictably increase your net worth is to save more. If you're nervous about the future, increase the amounts you're saving.

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