Just when you thought that the worst was behind us, we get a day like yesterday to remind us that all is not perfect in the merry ol’ land of Oz. The wicked witch came in the form of soaring crude-oil prices, accompanied by a couple of flying monkeys – that is, renewed concerns about the length and depth of the credit issues and hawkish comments from the Fed.
Before yesterday’s opening, crude oil prices had risen 35%, above $130. Wednesday’s additional $4.19 to $133.17 seemed surreal, as traders monitored data from the Energy Information Administration that showed U.S. oil reserves fell last week, contrary to expectations for modest growth in stockpiles. The timing was pretty rotten, especially if you were one of the oil executives grilled by the Senate Judiciary Committee about windfall profits and bloated executive pay yesterday.
As if oil itself were not enough to rattle investors, there was Ms. Meredith Whitney, the Oppenheimer financial sector gur-ess, who accurately nailed the credit crisis last year. She predicted that the credit crisis will continue into 2009 and that large financial institutions will likely incur credit-related losses of another $170 billion by the end of next year.
But what really seemed to spook investors yesterday was the release of the minutes of last month’s Federal Open Market Committee meeting. If you recall, the Fed cut rates by a quarter-point to 2% in April. What we learned from the minutes is that the cut was a "close call," and that future reductions are unlikely even if the economy gets worse. “Several members noted that it was unlikely to be appropriate to ease policy in response to information suggesting that the economy was slowing further or even contracting,” unless there was a “significant” weakening in the outlook. The minutes also revealed that Fed officials believe that the US economy will only increase by 0.3%-1.2% this year, as measured by GDP. The April estimate is lower than the previous forecast of 1.3% - 2%.
It seems to me that the economy and the markets have been fairly resilient, after taking an amazing number of blows over the past year. Yesterday’s action was a good reminder, though – while the economy and markets are healing, we are not yet done with the process. The dual bubbles that have burst in housing and credit have yet to be fully absorbed and the “crude realities” of skyrocketing oil are the biggest unknown facing investors in the short-term. Indeed, there are likely to be more trading sessions like yesterday’s, where you find yourself cringing.
Thursday, May 22, 2008
Wednesday, May 21, 2008
The Edge of Death
Two of my favorite pastimes are watching a market confound the pundits and a sports come-back story. It strikes me that in this pre-Memorial Day week, we are seeing both and there are important lessons that investors can take away in the process.
Let’s start with the amazing odyssey of Red Sox’ pitcher Jon Lester. Lester’s young career was stopped short in 2006, when he was diagnosed with a rare form of non-Hodgkin's lymphoma. Although he did not speak extensively about this period, we can only surmise that pitching statistics and wins and losses take a back seat to life and death. Lester, like so many cancer survivors, endured months of treatment, including aggressive chemotherapy, with the hope of life first, everything else next.
He returned to the Red Sox and on Monday night, and Lester took the mound against the Kansas City Royals. He had never even completed an entire game in his career, but on a fateful night at Fenway, Lester threw the first no-hitter of the Major League Baseball season and the 18th no-hitter in Red Sox history. One of my friends who is a doctor likes to describe the process of chemotherapy as “walking to the edge of death.” Imagine coming back from the edge to deliver this kind of performance?
On a much smaller and less important scale, I could not help think about another beast that went to the edge, only to come back. I am talking about the US stock market. It was only two months ago when the financial system was melting down and the near-collapse of Bear Sterns signifying the “edge of death.” Well, maybe not death, but certainly significant pain and suffering. You may recall that in mid-March, concerns were mounting that the market could suffer a massive pullback from an already-low level.
Since then, the market has gone through its own treatment of sorts: the drug of choice came in the form of a variety of Federal Reserve actions; benign economic numbers (US economic data have been lukewarm, but not as weak as some have originally feared); and better-than-expected first quarter earnings from non-financial sector companies. As a result, the financial system is healing. While we are not out of the woods yet (stubbornly-high oil and food prices make that impossible right now), things are improving. I wouldn’t expect any no-hitters from this market just yet, but in the past 6-8 weeks, the market has tilted towards an upside bias in the absence of specific bad news. That’s good enough for me after experiencing the metaphoric edge of death.
Let’s start with the amazing odyssey of Red Sox’ pitcher Jon Lester. Lester’s young career was stopped short in 2006, when he was diagnosed with a rare form of non-Hodgkin's lymphoma. Although he did not speak extensively about this period, we can only surmise that pitching statistics and wins and losses take a back seat to life and death. Lester, like so many cancer survivors, endured months of treatment, including aggressive chemotherapy, with the hope of life first, everything else next.
He returned to the Red Sox and on Monday night, and Lester took the mound against the Kansas City Royals. He had never even completed an entire game in his career, but on a fateful night at Fenway, Lester threw the first no-hitter of the Major League Baseball season and the 18th no-hitter in Red Sox history. One of my friends who is a doctor likes to describe the process of chemotherapy as “walking to the edge of death.” Imagine coming back from the edge to deliver this kind of performance?
On a much smaller and less important scale, I could not help think about another beast that went to the edge, only to come back. I am talking about the US stock market. It was only two months ago when the financial system was melting down and the near-collapse of Bear Sterns signifying the “edge of death.” Well, maybe not death, but certainly significant pain and suffering. You may recall that in mid-March, concerns were mounting that the market could suffer a massive pullback from an already-low level.
Since then, the market has gone through its own treatment of sorts: the drug of choice came in the form of a variety of Federal Reserve actions; benign economic numbers (US economic data have been lukewarm, but not as weak as some have originally feared); and better-than-expected first quarter earnings from non-financial sector companies. As a result, the financial system is healing. While we are not out of the woods yet (stubbornly-high oil and food prices make that impossible right now), things are improving. I wouldn’t expect any no-hitters from this market just yet, but in the past 6-8 weeks, the market has tilted towards an upside bias in the absence of specific bad news. That’s good enough for me after experiencing the metaphoric edge of death.
Tuesday, May 20, 2008
Hot Fun in the Summertime
End of the spring and here she comes back
Hi Hi Hi Hi there
Them summer days, those summer days
That's when I had most of my fun, back
high high high high there
Them summer days, those summer days
-Sly & The Family Stone
I love the summer and was disheartened to hear that due to the weak economy, some are scrapping their usual plans for a July-August break. According to a new survey commissioned by Access America, a travel insurance company, only 33 percent of Americans plan to take a summer trip this year, compared with 40 percent last year. The survey, conducted by Ipsos Public Affairs, also found that of those who do plan a trip, almost half are planning a lower cost trip by eating out less, spending fewer days away or staying closer to home.
Considering that US workers have the smallest number of vacation days of any industrialized nation in the world, we have to take what little time we have to re-charge our depleted batteries. That said, we all know that piling into the car and driving anywhere is going to cost a pretty penny this summer. According to AAA, the cost of gasoline is up to $3.80 per gallon for regular and $4.173 for premium. You don’t have to go far for those kinds of numbers to add up quickly.
So what’s a beleaguered consumer to do—forego hot fun in the summertime? Absolutely not! There are ways that we can all enjoy vacations that are more local in nature without breaking the bank. The first thing to do is head to your local bookstore and pick up a copy of a guide book about your city/state. You probably have not been to have of the tourist attractions that are within spitting distance of your home. I always marveled at the number of people that I knew in Providence, Rhode Island, who had not seen the basic “Top 10” sites in Boston, not to mention the vast number of New Yorkers who have never been to Ellis Island or the Statue of Liberty. If driving is a drag, consider the train or the bus and of feel free to touch base with your old college pal who lives in one of these places to see if a visit may be possible.
I know that there are cultural riches in your backyard that while are not Europe, are certainly memorable and wonderful in their own ways. I beg you to take your vacation time and sample the beauty and wonder of the wonderful place where you live this summer.
Hi Hi Hi Hi there
Them summer days, those summer days
That's when I had most of my fun, back
high high high high there
Them summer days, those summer days
-Sly & The Family Stone
I love the summer and was disheartened to hear that due to the weak economy, some are scrapping their usual plans for a July-August break. According to a new survey commissioned by Access America, a travel insurance company, only 33 percent of Americans plan to take a summer trip this year, compared with 40 percent last year. The survey, conducted by Ipsos Public Affairs, also found that of those who do plan a trip, almost half are planning a lower cost trip by eating out less, spending fewer days away or staying closer to home.
Considering that US workers have the smallest number of vacation days of any industrialized nation in the world, we have to take what little time we have to re-charge our depleted batteries. That said, we all know that piling into the car and driving anywhere is going to cost a pretty penny this summer. According to AAA, the cost of gasoline is up to $3.80 per gallon for regular and $4.173 for premium. You don’t have to go far for those kinds of numbers to add up quickly.
So what’s a beleaguered consumer to do—forego hot fun in the summertime? Absolutely not! There are ways that we can all enjoy vacations that are more local in nature without breaking the bank. The first thing to do is head to your local bookstore and pick up a copy of a guide book about your city/state. You probably have not been to have of the tourist attractions that are within spitting distance of your home. I always marveled at the number of people that I knew in Providence, Rhode Island, who had not seen the basic “Top 10” sites in Boston, not to mention the vast number of New Yorkers who have never been to Ellis Island or the Statue of Liberty. If driving is a drag, consider the train or the bus and of feel free to touch base with your old college pal who lives in one of these places to see if a visit may be possible.
I know that there are cultural riches in your backyard that while are not Europe, are certainly memorable and wonderful in their own ways. I beg you to take your vacation time and sample the beauty and wonder of the wonderful place where you live this summer.
Monday, May 19, 2008
Bubble Trouble
Last Friday, the Wall Street Journal ran a front-page story about the study of bubbles throughout history. (Bernanke’s Bubble Laboratory, by Justin Lahart, WSJ May 16, 2008). The article highlighted a group of intellectuals assembled at Princeton University to figure out how and why bubbles form and what should or should not be done to prevent or mitigate the bubbles from forming/popping.
Considering that we have seen two bubbles form (dot com and housing) and burst within ten years, the topic is quite timely. The Princeton group notes that bubbles often emerge when a significant innovation occurs—in the 1920’s, it was automobiles and electricity and in the nineties, it was the advent of the Internet. The interesting thing to consider is that most bubbles start with a great idea. Both automobiles/electricity and the widespread use of the Internet were truly transformative moments in time that would impact the economy in significant and lasting ways.
But what can occur is that the great idea morphs into a mania and then all bets are off. All of a sudden, everyone knows that what is going on is crazy, but nobody wants to be left out of the money-making. I remember talking to clients late in the Internet cycle and hearing “I know that it’s insane, but can’t we own more technology? My cousin has all of his money in the ABC Internet fund and has made a fortune!” Those animal instincts are so hard to fight, so maybe it’s up to a higher power to help us. The higher power in this case is the Federal Reserve.
Last week, Fed Governor Frederic Mishkin “suggested that while it was inappropriate to use the blunt instrument of interest-rate increases to prick bubbles, if too-easy credit appeared to be fueling a mania, policy makers might craft a regulatory response that could ‘help reduce the magnitude of the bubble.’” I am not sure what response Mishkin is thinking about, but there is a very easy solution that exists: change margin requirements.
One of the accelerants to a bubble is the use of borrowed money. As a result of leverage, bubbles become larger, faster, but once the tide turns, “the speed of their fall is intensified as investors sell urgently to pay down debt.” By requiring that investors use cash, not borrowed money, or in the case of housing, by ensuring that 20% down payments are used to secure mortgages, the Federal Reserve may not be able to prevent a bubble from forming, but it sure would make the eventual bursting of the bubble easier for the economy, markets and people to absorb.
Considering that we have seen two bubbles form (dot com and housing) and burst within ten years, the topic is quite timely. The Princeton group notes that bubbles often emerge when a significant innovation occurs—in the 1920’s, it was automobiles and electricity and in the nineties, it was the advent of the Internet. The interesting thing to consider is that most bubbles start with a great idea. Both automobiles/electricity and the widespread use of the Internet were truly transformative moments in time that would impact the economy in significant and lasting ways.
But what can occur is that the great idea morphs into a mania and then all bets are off. All of a sudden, everyone knows that what is going on is crazy, but nobody wants to be left out of the money-making. I remember talking to clients late in the Internet cycle and hearing “I know that it’s insane, but can’t we own more technology? My cousin has all of his money in the ABC Internet fund and has made a fortune!” Those animal instincts are so hard to fight, so maybe it’s up to a higher power to help us. The higher power in this case is the Federal Reserve.
Last week, Fed Governor Frederic Mishkin “suggested that while it was inappropriate to use the blunt instrument of interest-rate increases to prick bubbles, if too-easy credit appeared to be fueling a mania, policy makers might craft a regulatory response that could ‘help reduce the magnitude of the bubble.’” I am not sure what response Mishkin is thinking about, but there is a very easy solution that exists: change margin requirements.
One of the accelerants to a bubble is the use of borrowed money. As a result of leverage, bubbles become larger, faster, but once the tide turns, “the speed of their fall is intensified as investors sell urgently to pay down debt.” By requiring that investors use cash, not borrowed money, or in the case of housing, by ensuring that 20% down payments are used to secure mortgages, the Federal Reserve may not be able to prevent a bubble from forming, but it sure would make the eventual bursting of the bubble easier for the economy, markets and people to absorb.
Friday, May 16, 2008
Back to the Beach Bet
Last August, I made a bet with a hedge fund guy. He was sure that the economy was going into the tank and that the US would plunge into a deep and prolonged recession that would start at the end of 2007 and last well into 2008. I countered that I didn’t think that the US would see two negative quarters by the end of the first quarter of 2008. On the beach at Ditch Plains, Montauk, the bet was wagered: the winner would be treated to a large Sicilian pie from Umberto’s of New Hyde Park. I have resisted calling until the final revisions to GDP are in, but I am starting to think about what toppings I want on my pizza.
The bet never contemplated all of the wild events that have occurred since then, but this week, both the New York Times and Wall Street Journal noted that while the economy is hurting, it has not yet met the non-official definition of a recession, that is, two consecutive quarters of negative GDP. GDP for Q4 2007 and Q1 2008 was lame at +0.6%, but at least it was positive. The Times’ David Leonhardt noted that “you can make an argument that the economy has survived its period of maximum danger.”
Of course surviving does not equate thriving, but it is a far better outcome than many thought possible just six weeks ago. I like to call this period “Post-Bear Stearns” because in the time since the near-collapse of the fifth largest US investment bank, financial markets and the economy retreated from the brink of disaster. Credit goes primarily to the Federal Reserve, which has been both creative and aggressive in staving off a more significant crisis. The collective sigh of relief continues to reverberate from Wall Street to Main Street. Maybe that’s why retail sales were better-than-expected when they were released this week.
That doesn’t mean that everything is honky-dory. The housing market is still lousy (official term), job losses may have eased, but it would be better if the economy created jobs instead of losing them and then there’s that oil problem. Adding to that list, Federal Reserve Chairman Ben Bernanke said that conditions in financial markets are “far from normal…pressures in short-term funding markets persist.”
Where does that leave us? Well, the economy is weak and may in fact worsen in the coming months. Consumers who have held up pretty well might buckle under higher energy costs this summer and another shoe could drop in the credit crisis. But thus far, we have come through this difficult period in pretty good shape. And of course, it looks like I will be winning that pizza because the bet was a time limited one.
The bet never contemplated all of the wild events that have occurred since then, but this week, both the New York Times and Wall Street Journal noted that while the economy is hurting, it has not yet met the non-official definition of a recession, that is, two consecutive quarters of negative GDP. GDP for Q4 2007 and Q1 2008 was lame at +0.6%, but at least it was positive. The Times’ David Leonhardt noted that “you can make an argument that the economy has survived its period of maximum danger.”
Of course surviving does not equate thriving, but it is a far better outcome than many thought possible just six weeks ago. I like to call this period “Post-Bear Stearns” because in the time since the near-collapse of the fifth largest US investment bank, financial markets and the economy retreated from the brink of disaster. Credit goes primarily to the Federal Reserve, which has been both creative and aggressive in staving off a more significant crisis. The collective sigh of relief continues to reverberate from Wall Street to Main Street. Maybe that’s why retail sales were better-than-expected when they were released this week.
That doesn’t mean that everything is honky-dory. The housing market is still lousy (official term), job losses may have eased, but it would be better if the economy created jobs instead of losing them and then there’s that oil problem. Adding to that list, Federal Reserve Chairman Ben Bernanke said that conditions in financial markets are “far from normal…pressures in short-term funding markets persist.”
Where does that leave us? Well, the economy is weak and may in fact worsen in the coming months. Consumers who have held up pretty well might buckle under higher energy costs this summer and another shoe could drop in the credit crisis. But thus far, we have come through this difficult period in pretty good shape. And of course, it looks like I will be winning that pizza because the bet was a time limited one.
Thursday, May 15, 2008
Wonder, Blunder, Thunder and Plunder
I recently heard a legendary consultant deliver a great talk about managing closely-held businesses. He identified what he termed, “the four stages of entrepreneurial endeavors: Wonder, Blunder, Thunder and Plunder!” I could not help but translate this to your financial life, but in order to do so, I need to review each step and then apply it to what I will call the four stages of personal financial management.
“Wonder” begins with nothing—you have no business, no clients, no money, but you are filled with optimism. Most folks in this stage run the business—and that is a loose term, considering that it is just a dream at this point—by the seat of the pants. In personal financial management, this is where we all begin, unless we are lucky enough to be born into a family with lots of money. You remember when you got that first job and started to figure out that the government takes an awfully large portion of your check (“Dad-I think there’s a mistake with my pay stub!”) and you could barely pay your rent, but it was all new and exciting.
“Blunder” is when things start moving at warp speed. The business finally has profits, but no cash. In other words, the little idea has become a business, but there is tremendous stress and the owner clings to a crisis mode of management. In your real life, this is the period where you can’t believe that you made so much money and have nothing to show for it at the end of the year. Sure, you pay your bills and even have a house, but it feels like you are living paycheck to paycheck and there is no plan in place to help you get to the next place.
“Thunder” is a more mature phase of the business. The boss has become loud, opinionated, obnoxious and over-confident. He has formalized the management structure, but mostly so he can lecture the staff about his numerous ideas. This is often met with nods of agreement to his face and extreme eye-rolling behind his back. But nobody wants to rock the boat-the company is finally profitable and everyone is glad to be making money. In personal finance, this is usually when people accumulate real money for the first time in their lives, often through their retirement accounts. They usually do not have a plan, but “the numbers speak for themselves.” As a result, the Thunder-guy/gal believes that he/she knows better and does not need anything more. I always hope to meet people during the Thunder phase—it is when wealth management can have the most significant impact on the client’s life and can actually create opportunities for those who get on board with the process before the next stage robs them of possibilities.
The final stage, “Plunder,” is the fork in the road: it can either be a period of renewal or decline. It is a time when change smacks the entrepreneur in the face, as all of the “wisdom” that he has relied upon is now obsolete. If the business is fortunate, this is the moment when the boss recognizes that he must make changes or the business will slowly drift away.
In personal finance, Plunder usually occurs when the stock market swoons or during life-changing times like job-loss, disability or even death. It can be the moment when a couple faces up to the fact that the non-strategy that has been at play can not possibly see them through retirement and in fact, may be the reason that dreams must be put on hold. While I can also help those who are in the early part of Plunder, when they wait too long, I find that most suggestions are met with “yeah, but…” and they are simply going to plunder opportunity due to stubbornness.
“Wonder” begins with nothing—you have no business, no clients, no money, but you are filled with optimism. Most folks in this stage run the business—and that is a loose term, considering that it is just a dream at this point—by the seat of the pants. In personal financial management, this is where we all begin, unless we are lucky enough to be born into a family with lots of money. You remember when you got that first job and started to figure out that the government takes an awfully large portion of your check (“Dad-I think there’s a mistake with my pay stub!”) and you could barely pay your rent, but it was all new and exciting.
“Blunder” is when things start moving at warp speed. The business finally has profits, but no cash. In other words, the little idea has become a business, but there is tremendous stress and the owner clings to a crisis mode of management. In your real life, this is the period where you can’t believe that you made so much money and have nothing to show for it at the end of the year. Sure, you pay your bills and even have a house, but it feels like you are living paycheck to paycheck and there is no plan in place to help you get to the next place.
“Thunder” is a more mature phase of the business. The boss has become loud, opinionated, obnoxious and over-confident. He has formalized the management structure, but mostly so he can lecture the staff about his numerous ideas. This is often met with nods of agreement to his face and extreme eye-rolling behind his back. But nobody wants to rock the boat-the company is finally profitable and everyone is glad to be making money. In personal finance, this is usually when people accumulate real money for the first time in their lives, often through their retirement accounts. They usually do not have a plan, but “the numbers speak for themselves.” As a result, the Thunder-guy/gal believes that he/she knows better and does not need anything more. I always hope to meet people during the Thunder phase—it is when wealth management can have the most significant impact on the client’s life and can actually create opportunities for those who get on board with the process before the next stage robs them of possibilities.
The final stage, “Plunder,” is the fork in the road: it can either be a period of renewal or decline. It is a time when change smacks the entrepreneur in the face, as all of the “wisdom” that he has relied upon is now obsolete. If the business is fortunate, this is the moment when the boss recognizes that he must make changes or the business will slowly drift away.
In personal finance, Plunder usually occurs when the stock market swoons or during life-changing times like job-loss, disability or even death. It can be the moment when a couple faces up to the fact that the non-strategy that has been at play can not possibly see them through retirement and in fact, may be the reason that dreams must be put on hold. While I can also help those who are in the early part of Plunder, when they wait too long, I find that most suggestions are met with “yeah, but…” and they are simply going to plunder opportunity due to stubbornness.
Wednesday, May 14, 2008
The Professor Speaks
Have you ever looked at one of those graphs that looks like you can’t lose if you buy stocks? Of course you know that you can lose at any given year during the period highlighted, but these graphic illustrations are supposed to help you understand that if you have the intestinal fortitude to hold the volatile asset class of stocks during the ups and downs, you too can climb the mountain and end up with a bunch of money.
Want proof? If you had a great-great grandparent who purchased a dollar worth of US stocks in January, 1802 and you had inherited the position and held it until the end of 2007, you would have $766,854, or an inflation-adjusted annualized return of 6.8%. As a means of comparison, a dollar invested in bonds would get you $1,320, or a 3.5% annualized return. Parenthetically, if your relative bought a dollar piece of gold in 1802, it’s only worth $2.45 today (including the recent run-up) and the US dollar is actually worth -$0.06, or less than a dollar!
I was reminded of all of these numbers after attending a lecture delivered by legendary professor/writer/commentator Jeremy J. Siegel of the Wharton School of the University of Pennsylvania. Professor Siegel wrote the famous investment book Stocks for the Long Run (now in its fourth edition) for ordinary investors, so I wondered how the group of know-it-all investment advisors would respond to him. I am here to report that the Professor can captivate a room of even the most jaded insiders.
It was like attending a master class with Maria Callas. Professor Siegel started with the basics and built from there. Some key points that got the room nodding in unison included a reminder that the current yield of US Treasury bonds is 3.74%, but this is a nominal yield---it is necessary to calculate the real yield, which subtracts the inflation rate, which even at an assumption of 2.5%, would only get you 1.24%, not including the tax liability that you have by owning this asset class. This does not mean that you should never own bonds, but if you do purchase bonds, you should understand how they compare to stocks over a period of time. Professor Siegel noted that from 1926-2007, stocks yielded a real annualized return of 6.7%, and if we assume a similar future performance, then bonds look like a pretty rotten investment next to stocks.
Does this mean that you should only own stocks? Perhaps if you subscribe to this theory, you would trot out the mother of all bull markets--1981-1999, a time period when the annualized return of 13.6% (bonds did pretty well too, earning 8.4%). The bears would encourage the optimists to look at 1966-1981, when the annualized real return of stocks was actually -0.4%--ouch! These two periods are bookmarks, which is why Professor Siegel always comes back to his assumption of 6.7% as a long-term return, which happens to be the annualized return from 1926-2007.
But here is the thing about the Professor—his statistics are absolute, but as I have said many times, investors are human beings and very few have the ability to stay invested in a portfolio comprised of 100% stocks. The Professor’s research may show that a diversified portfolio actually eats into potential returns, but I look at statistics from the real world---it may be that a diversified portfolio will save an investor from himself and prevent an emotional response to market moves. For more of this kind of data, you should read Stocks for the Long Run and Professor Siegel’s newest book, The Future for Investors: Why the Tried and the True triumphs over the Bold and the New.
Want proof? If you had a great-great grandparent who purchased a dollar worth of US stocks in January, 1802 and you had inherited the position and held it until the end of 2007, you would have $766,854, or an inflation-adjusted annualized return of 6.8%. As a means of comparison, a dollar invested in bonds would get you $1,320, or a 3.5% annualized return. Parenthetically, if your relative bought a dollar piece of gold in 1802, it’s only worth $2.45 today (including the recent run-up) and the US dollar is actually worth -$0.06, or less than a dollar!
I was reminded of all of these numbers after attending a lecture delivered by legendary professor/writer/commentator Jeremy J. Siegel of the Wharton School of the University of Pennsylvania. Professor Siegel wrote the famous investment book Stocks for the Long Run (now in its fourth edition) for ordinary investors, so I wondered how the group of know-it-all investment advisors would respond to him. I am here to report that the Professor can captivate a room of even the most jaded insiders.
It was like attending a master class with Maria Callas. Professor Siegel started with the basics and built from there. Some key points that got the room nodding in unison included a reminder that the current yield of US Treasury bonds is 3.74%, but this is a nominal yield---it is necessary to calculate the real yield, which subtracts the inflation rate, which even at an assumption of 2.5%, would only get you 1.24%, not including the tax liability that you have by owning this asset class. This does not mean that you should never own bonds, but if you do purchase bonds, you should understand how they compare to stocks over a period of time. Professor Siegel noted that from 1926-2007, stocks yielded a real annualized return of 6.7%, and if we assume a similar future performance, then bonds look like a pretty rotten investment next to stocks.
Does this mean that you should only own stocks? Perhaps if you subscribe to this theory, you would trot out the mother of all bull markets--1981-1999, a time period when the annualized return of 13.6% (bonds did pretty well too, earning 8.4%). The bears would encourage the optimists to look at 1966-1981, when the annualized real return of stocks was actually -0.4%--ouch! These two periods are bookmarks, which is why Professor Siegel always comes back to his assumption of 6.7% as a long-term return, which happens to be the annualized return from 1926-2007.
But here is the thing about the Professor—his statistics are absolute, but as I have said many times, investors are human beings and very few have the ability to stay invested in a portfolio comprised of 100% stocks. The Professor’s research may show that a diversified portfolio actually eats into potential returns, but I look at statistics from the real world---it may be that a diversified portfolio will save an investor from himself and prevent an emotional response to market moves. For more of this kind of data, you should read Stocks for the Long Run and Professor Siegel’s newest book, The Future for Investors: Why the Tried and the True triumphs over the Bold and the New.
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