The world is changing and investors have to make some difficult choices as they try to navigate in a rapidly shifting economic landscape.As reported in Time Magazine, "over the past two centuries, stocks have done dramatically better for investors than have bonds or any other asset class. Stocks, we have been told again and again through the years, are the best long-term investment. Prices go up and they go down, but give stocks enough time and they deliver returns that trounce those of bonds, real estate, commodities or any other asset class"
In 1922, Edgar Lawrence Smith was amongst the first to provide evidence that stocks beat bonds as a long term investment. Although this unravelled in 1929, subsequent investigations (1938, '53, '64, '76 and '94) corroborated the fact that stocks are an excellent long-run investment.
Despite the historical evidence, past performance is no guarantee of future results and this is particularly true today with the global economy in a state of flux. As reported in another Time Magazine article, since the dawn of the new millennium traditional stock has not performed as well as it has previously. This has prompted some analysts to question the notion that stocks are good for the long haul.
Stock market data from the last 9 years indicate the long hold position does not bear up to scrutiny. "Since the beginning of this decade, the stock market has been a money pit. At the market's nadir in early March, stock investors had lost more than 50% since March 2000."
A Time Magazine article entitled Investing for Recovery, indicates that investors continue to apply traditional market logic by investing in financial companies, retailers and technology firms. But as explained by First Eagle's Jean-Marie Eveillard, one of the few managers to produce positive returns when stocks plunged earlier this decade, "it's a very different story today. The landscape is different, and the recovery, when it comes, probably won't be along the lines of what we have seen in the post--World War II period."
Traditional logic is more likely to apply if we have a recession that bottoms out and rebounds quickly (V shaped). But we are already well beyond the mean and with concerns about consumer spending, this recession is taking longer to rebound (U shaped). Some are suggesting that massive government spending could hurt the value of the dollar. If that happens inflation will result and the best tool against inflation is raising interest rates. But if the Federal Reserve is forced to raise rates, the economy could lapse back into recession. (This is the double dip, or the W).
Over the last 2 decades, the myth of the rational market has obscured the statistical truth and blinded many investors to the fact that in a globalized economy problems can quickly become systemic.
Milton Friedman never believed markets were perfectly rational, but he thought they were more rational than governments. Friedman believed speculators tended to stabilize markets rather than unbalance them.
In tbe 1960s Paul Samuelson made the mathematical case for the randomness of the stock market. Then in 1969 Eugene Fama developed the efficient-market hypothesis, in which he defined an efficient market as one in which prices always 'fully reflect' available information.
In the 1970s a new approach to investing and risk management incorporated index funds, risk-weighted portfolio allocation and mathematical models to price options and other derivatives. Although these are useful tools they are premised on the notion that "prices were reliable reflections of economic reality."
Over the years there have been many challenges to the core assumptions of the rational market, and even Fama's own retesting gave him reason to question his efficient-market hypothesis.
"Unwillingness to countenance the possibility that market prices might be wildly wrong defined the behaviour of regulators, corporate executives and most Wall Streeters during both the tech-stock and real estate bubbles...the strong performance of the U.S. stock market and economy tended to silence doubts"
"The issue isn't whether financial markets are useful--they are--or whether the prices of stocks or bonds or collateralized debt obligations convey information--they do. There's also much to be said for the insight at the heart of efficient-market theory: markets are hard to outsmart. But when we give up second-guessing the market, we suspend our judgment."
Particularly in this atypical economy, stocks should be judged by the relative value they offer (low cost relative to earnings, book value and other fundamental measures). Today advantageous prices make many stocks a great investment opportunity. Further when compared to standard fixed-rate bonds, stocks may be a better option as they are less likely to be devalued by inflation.
Investors are faced with declining stock market yields as many traditional industries are sagging under the weight of this recession. With traditional investment strategies proving to be less profitable then in previous generations, investors are tasked with developing alternatives.
According to the "World Wealth Report 2008" high net worth individuals are investing in clean tech and contributing to wealth generation. In 2007, total investments in clean technology added up to $117 billion, up 41 percent from investments in 2005. Venture capital investments went from $3.6 billion in 2006 to $5.2 billion in 2007.
Governments are also showing strong support for sustainable enterprise. In the US, even before the current administration, there was a $700 billion 'bailout' package that provided tax credits for solar energy properties, production tax credits for wind energy, geothermal and other renewable energy resources, and tax deductions for energy-efficient commercial buildings.
Despite the current economic environment, sustainability is not a frill. It is a relatively quick, money-saving fix for corporations struggling to lower energy, water and waste costs. Going forward, we can expect to see even greater emphasis on sustainable investments.
We live in a world where we can no longer depend on the traditional wisdom of previous generations of investors. Although diversification remains the best way to mitigate risk, a lot of smart money is being invested in sustainable stock.
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2 comments:
Economist say that the stimulus should have been bigger, and should have been more direct inputs into the economy vs ephemeral tax cuts.
While I agree with the economists who advocated for larger scale government investments, political obstructionsim from conservatives made this impossible.
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