If you want to know why, for most people, their house is a better investment than stocks, read David Stockman’s New York Times jeremiad “Sundown in America.” It is alarming articles like this that convince investors to avoid buying stocks until they have climbed a lot and look “safe” — and then to sell them during recessions after they have plunged in price. The result is terrible long term performance. Call it the “liquidity trap.” People don’t sell their home during a recession because it is illiquid and they need a place to live. Stocks, by contrast, are easy to buy near the top and sell at the bottom.
Stockman’s article is full of mistakes. For example, “the Fed’s unforgiveable bailout of the hedge fund Long-Term Capital Management” never happened. Wall Street firms, not the Fed, provided liquidity to unwind the fund, and the original investors lost all their money. Another mistake: he forgets that debt/GDP accelerated in the 1980s because inflation and therefore nominal GDP growth—declined. Obviously disinflation was positive, not negative. But Stockman’s scary sundown story is instructive nonetheless because its omissions and distortions illustrate five important lessons for long-term investors:
The “Good Old Days” sucked too. Stockman portrays the century before 1980 as saner and safer because debt / GDP averaged just 160%, versus 350% now. Alas, according to the National Bureau of Economic Research, there were 24 “contractions” (recessions or depressions) during that century, so the economy was contracting a third of the time. Believe me, the “good old days” 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.
Stocks Can Survive Government Mismanagement. According to Stockman the “sundown” started in 1982, when debt growth accelerated and the U.S. fell into a hopeless abyss of crony capitalism. Nevertheless since 1982 stock prices have climbed 1,302% (8.9% CAGR) while paying an average dividend yield of 2.6%. The 2013 dividend represents a 31% yield on the March 31, 1982 price. This is a disaster you can retire on.
S&P Is Not GDP Stockman claims today’s “bubble” was inflated by Fed liquidity “rather than real economic gains.” Wrong; earnings have climbed as much as stock prices since 2009, as detailed in our latest post. More broadly, the woes of the “main street economy” are not strictly germane to equity investors, who mainly own giant multinationals which are faring much better than small business because: A) instead of being hurt by the Internet, giant firms build, own, and operate the web; B) they have high exposure to fast-growing emerging markets; C) they have more capital equipment per worker, and therefore higher labor productivity and faster productivity growth; D) they are better able to fight through Washington’s reams of red tape; E) they have excess capital and cash flow, permitting share buy-backs and acquisitions. These factors account for strong recent profit growth despite a weak U.S. economy.
The Financial Economy is not the Real Economy Stockman gleefully details the misadventures of Wall Street without mentioning the extraordinary achievements of other industries – the Internet, the fracking revolution, the railroad renaissance, biotech’s transformation of healthcare and agriculture, or the rise of potent consumer franchises such as Wal-Mart, Costco, McDonalds, Nike, Starbucks, Panerra, Amazon, and Wynn Resorts, to name a few.
Known Risks Are Less Dangerous. After a tedious tour of five decades of financial folly, Stockman gets to his main point: “when the Fed….even hints at shrinking its balance sheet, it will elicit a tidal wave of sell orders” in the bond market. In contrast to the housing bubble, everyone—even the Fed—knows this is a risk and will behave accordingly. As noted in my last post, the stock market is not assuming bond yields stay at 2% forever. In fact a bond bear market could scare some money into equities, which are more reasonably valued than bonds.
Macro Policy Is Improving
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. Obama’s 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. Washington is finally considering policies that would actually boost growth, such as immigration reform, entitlement reform, and tax reform. Eventually Obamacare will be reformed because it is unworkable and unpopular.
Bottom Line
Buy and hold is difficult and unfashionable, but it works. 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. 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 Stockman’s Scary Sundown.
Copyright 2013 Thomas Doerflinger. All Rights Reserved.
