Monday, August 20, 2012

Stock Market Performance and Economic Growth

Let's connect the completely obvious but all too often ignored combination of (1) long term stock market performance and (2) the long term health of our economy.

In other words, strong private companies are essential to a prosperous, stable and secure America. Storng companies make for healthy stock price performance over time as well.

This long term stock market health very much includes the preservation of real inflation adjusted purchasing power. In turn, that allows us to keep our nation's promises to pay for the retirement promises we make to our fellow citizens, including ourselves, with respect to Medicare and Social Security benefits, as well as public and private sector pensions and 401(k)s, too.

Simply put, we need a strong, stable and growing private sector to create long term wealth and prosperity for all of our U.S. citizens, children, workers and retirees all included, in both the private and public sectors. Stock prices are the key metric over time as they reflect how our private sector companies are faring in the competitive global marketplace.

In this regard, Burton Malkiel, author of the long running best selling "A Random Walk Down Wall Street," remains a huge proponent of the benefits of long term stock ownership.

In an editorial titled  Even Amid the Current Turmoil, Stocks Still Beat Bonds, Mr. Malkiel has this to say about the current market and its gyrations:

"The stock market continues to reflect the very modest economic recovery now under way in the United States. From January 2011 through mid-August 2012, the S&P 500 has produced moderate single-digit total returns. But many individual investors are not participating. Some $200 billion has flowed out of equity mutual funds since January 2011. Even more has flowed into bond funds, leading bond king Bill Gross to proclaim "the cult of equity is dying." Yet I believe that investors who pull their money out of the stock market today to invest in bonds are making a huge mistake.

Granted, the litany of uncertainties worrying investors is a long one. Europe is in recession, and it is far from clear that the euro zone will hold together. China is slowing. The U.S. risks falling off a "fiscal cliff" and, of course, election-year and tax-policy uncertainty abound. But there are always economic uncertainties.

The more persistent uncertainty plaguing individual investors is the fear that our markets are not working properly. . . .

And the recent fiasco concerning Knight Capital and its errant computer that kept feeding incorrect orders into the market with no "stop button" is the latest strand in a long string of market meltdowns from the "crash of 1987" to the "flash crash" of 2010. Such "Knightmares" have convinced many individual investors that our stock markets are broken and that they are at a huge disadvantage relative to the pros. Neither of these propositions is true. . . .

Should individual investors have reason to abandon the stock market because of the increased volatility rapid-fire trading can cause? Not at all. Investors saving for retirement have no reason to fear day-to-day or week-to-week volatility. The correct response is not to "do something" but rather to "just stand there." Evidence continues to accumulate that the long-term investor who simply buys and holds low-cost broad-based index funds and (indexed) ETFs does not achieve mediocre returns but well-above-average returns. During 2011, index-fund investors outperformed over 80% of actively managed equity funds. The same results have continued in the first half of 2012.

Moreover, equities today are more attractive relative to bonds than at any other time in history. Locking retirement funds into "safe" 1.5% yielding Treasury securities is likely to be a sure loser after inflation. We live in a world where the developed nations are saddled with large indebtedness relative to income (i.e., GDP) and large fiscal deficits. Moreover, our aging populations will put even greater strains on entitlement programs over time. Thus far, the major action taken in Washington with respect to entitlements has been to increase coverage, not decrease costs. The political path that seems easiest is to keep interest rates low and hope that inflation will eventually reduce our indebtedness as it has in the past.

In this low-return environment, saving for retirement is extremely difficult. The return assumptions for most pension plans tend to be overly optimistic. Certainly, fixed-income investments will never earn the projected returns required. The only hope—both for individuals and for institutions running retirement portfolios—is to increase, not decrease, the share of the portfolio devoted to equities."

Summing Up

Stay with stocks.

Ignore the daily, weekly, monthly and even annual gyrations of the market.

Over the long term in a free market based economy, stocks will outperform bonds, real estate, gold and other forms of investment.

That's the entire basis behind the risk-reward principle.

If there would be no reward for taking a prudent "owership" risk, nobody would take that risk.

Capitalism works to increase a society's standard of living and that of its individual citizens.

Stay with blue chip, cash generating, dividend paying, earnings increasing, innovating and well managed companies.

That's the best and, in my view, only real "safe" way to improve purchasing power and build assets over time.

Thanks. Bob.

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