Stocks for the (Very) Long Run

From John Authers's column in today's Financial Times ("Long View: Why baby boomers will put their faith in bonds"):

US stocks have now underperformed Treasury bonds since 1969. Very few savers actively putting money away today started much before 1969. Most of them did so during a period when the cult of the equity held sway. For this whole generation, that belief in equities has proved badly misplaced. Various long-term surveys show that there have been very long periods of underperformance by equities in the past.

But we can say that the current sell-off is almost without precedent for its speed. [Research Affiliates' Rob] Arnott’s figures show that as Wall Street opened on Friday it was already dealing with the second biggest six-month decline in its history. The only bigger six-month drop was barely larger, at 51 per cent, at the end of the crash of 1932.

The good news is that 1932 marked the bottom of the great bear market of the 1930s, and that stocks rallied more than 100 per cent in a matter of weeks.

The bad news is that there were still 22 years to go before stocks regained their highs in nominal terms, and 26 years before they regained their highs in real terms, an event that did not happen until 1958.

[...]

All of this could shatter our confidence in stocks as the vehicle for the long run. While the evidence is still unequivocal that they do perform best over the very long term, the periods may be so long that they do not help some people during their lifetimes.

A couple of thoughts on this:

1) The shattering of confidence Authers mentions above, and the associated revulsion toward stocks, explains the multiple compression that Vitaliy Katsenelson wrote occurs during secular range-bound (or bear) markets (see his graphic above, or this post for elaboration on Katsenelson's thesis).

2) This column wouldn't have been a revelation to Benjamin Graham. Unlike the advocates of buy & hold indexing in recent years, Graham was well aware that stocks, broadly speaking, could under-perform for painfully long periods. Graham wrote this on p.12 of the third edition of his Security Analysis, which was published in 1951:

"Prior to 1929, one could say with some logic that the course of common stock prices appeared to be so determinedly upward that the intending holder of high-grade stocks for investment could afford to buy them at any time and to ignore their fluctuations. In the past 20 years there is no longer any clear-cut evidence of an underlying and persistent upward trend in common stocks taken as a whole."

Hence, Graham focused on investment strategies that didn't rely on a secular bull market lifting most stocks¹. Incidentally, he didn't know it when he wrote the quote above, but a new secular bull market had already begun when the third edition of Security Analysis was published -- one that would continue for about another 15 years.

The graphic above is from Katsenelson's website.

¹Worth remembering though that even Graham took a beating during the Great Crash: According to James Grant, in his introduction to the latest edition of Security Analysis, Graham lost 70% of his money (The Dow dropped 89.5% over the same 1929-1932 period).

Former Australian PM Blames Financial Crisis on Geithner

Today's Sydney Morning Herald reports comments made by former Australian Prime Minister Paul Keating about Tim Geithner at a recent speech in Sydney ("Obama's economic saviour savaged as Keating lets rip"). Excerpts:

When Barack Obama announced his champion to rescue the world from economic ruin, it was the first time most Americans had ever heard the name Tim Geithner.

The initial impression was good. The stockmarket surged and the pundits swooned.

[...]

If anyone in the US media had thought to ask a former Australian prime minister for his assessment, they would have heard a different view. And they would not have been so surprised at Geithner's performance since.

In a speech to a closed gathering at the Lowy Institute in Sydney on Thursday, Paul Keating gave a starkly different account of Geithner's record in handling the Asian crisis: "Tim Geithner was the Treasury line officer who wrote the IMF [International Monetary Fund] program for Indonesia in 1997-98, which was to apply current account solutions to a capital account crisis."

In other words, Geithner fundamentally misdiagnosed the problem. And his misdiagnosis led to a dreadfully wrong prescription.

[...]

Geithner thought Asia's problem was the same as the ones that had shattered Latin America in the 1980s and Mexico in 1994, a classic current account crisis.

[...]

But the Asian crisis was completely different.

[...]

But Geithner, through his influence on the IMF, imposed the same cure the IMF had imposed on Latin America and Mexico. It was the wrong cure. Indeed, it only aggravated the problem.

Keating continued: "[former Indonesian leader] Soeharto's government delivered 21 years of 7 per cent compound growth. It takes a gigantic fool to mess that up. But the IMF messed it up. The end result was the biggest fall in GDP in the 20th century. That dubious distinction went to Indonesia. And, of course, Soeharto lost power."

Exactly who was the "gigantic fool"? It was, obviously, the man who wrote the program, Geithner, although Keating is prepared to put the then managing director of the IMF, the Frenchman Michel Camdessus, in the same category.

Worse, Keating argued, Geithner's misjudgment had done terminal damage to the credibility of the IMF, with seismic geoeconomic consequences: "The IMF is the gun that can't shoot straight. They've been making a mess of things for the last 20-odd years, and the greatest mess they made was in east Asia in 1997-98, so much so that no east Asian state will put its head in the IMF noose."

China, in particular, drew hard conclusions from the IMF's mishandling of the Asian crisis. It decided that it would never allow itself to be dependent on the IMF, or the US, or the West generally, for its international solvency. Instead, it would build the biggest war chest the world had ever seen.

[...]

"These reserves are so large at $US2 trillion as to equal $US2000 for every Chinese person, and when your consider that the average income of Chinese people is $US4000 to $US5000, it's 50 per cent of their annual income. It's a huge thing for a developing country to not spend its wealth on its own development."

[...]

Keating went on to argue that, by frightening the Chinese into building their vast $US2 trillion foreign reserves, Geithner was responsible for the build-up of tremendous imbalance in the world financial system. This imbalance, in turn, according to Keating, contributed to the global financial crisis which has since devastated the world economy.

Hat tip to a couple of commenters in the comment thread of a post ("Should Geithner Go?") on Megan McCardle's Atlantic blog.

The photo above, of Tim Geithner, is from the Affordable Housing Institute.

Atlas Shrugging

Ayn Rand's novel Atlas Shrugged has come up a lot recently in commentary about Obama administration initiatives (e.g., this column by Robert Tracinsky last week, "The Ayn Rand Factor In the Santelli Revolt"). Since one of Daniel Wahl's favorite posts (#5) on his old blog expressed Randian sentiments, I mentioned the Tracinsky column to him and suggested he might want to consider writing a post on the subject at his new blog, Systemically Important. Daniel hasn't written a post there on Atlas Shrugged yet (Today's Systemically Important post is "Mottos: Business Peopleguys"), but several other bloggers have, including Will Wilkinson (Hat Tip: Ross Douthat). For those who haven't read Atlas Shrugged and plan to, be warned that Wilkinson's post ("On Going Galt"), and the parts of it I'm about to excerpt below, include some spoilers.

Wilkinson:

I can’t help but feel that threatening to withdraw from economic production, ala Atlas Shrugged’s John Galt, is a certain kind of libertarian-conservative’s version of progressives threatening to move to Canada.

[...]

But insofar as this is all about taxes on the wealthy (as the link to Malkin suggests) it’s a bit hard to see tax rates somewhat exceeding the Clinton era’s as a move over some inflection point from the tolerable to the completely outrageous. And of course none of these folks designed an engine that would have created basically free energy (and made global warming a non-issue). In the individual case, “going Galt” smacks of a kind self-aggrandizement in the same way that climate smuggery does. Because, really, your marginal contribution doesn’t matter that much.

By the way, Atlas buffs, the point of Atlas Shrugged is not that you are John Galt. The point is that you are not John Galt. The point is that you are, at your best, Eddie Willers. You’re smart, hardworking, productive, and true. But you’re no creative genius and you take innovation — John Galt — for granted. You don’t even know who he is! And this eventually leaves you weeping on abandoned train tracks. 

Wilkinson makes a good point in that last paragraph, one I thought was plain when I read the book years ago, but this misunderstanding seems to be shared by some Atlas Shrugged detractors as well as buffs. Back to Wilkinson:

I think Obama’s policies will be bad for innovation, but not because higher marginal tax rates will lead our best and brightest to retire from the field of endeavor. I’m rather more worried that our best and brightest will follow the incentives and go Robert Stadler. I’m worried that our money, which might otherwise have gone to capitalize real innovation, will be confiscated in order to finance government directed “investment” instead. Our economy can readily absorb a passel of drop-out Willerses (though Eddie never quits!). It’s the misdirected capital embodied by the Stadlers and their Project Xes that really hurts.

Wilkinson is less convincing there. All things equal, additional government spending on scientific research (e.g., National Institutes of Health research grants) would probably increase innovation. The bigger potential threat to innovation isn't increased government spending per se¹, but the prospect of price controls (de facto or de jure) or rationing that might be part of a universal national health insurance program.

¹Increased government spending on transfer payments could indirectly stifle innovation if it increased pressure for price controls or reduced reimbursements in a universal government health insurance program.

I borrowed the image above, of the cover of a paperback edition of Atlas Shrugged, from this blog, which I'm sure borrowed it from Amazon.com or somewhere else.

Update: Daniel Wahl joins the discussion with his latest post: "Going Going Galt".

More Buyer's Remorse

From Stewart Taylor's essay in the National Journal ("Obama's Left Turn"):

Having praised President Obama's job performance in two recent columns, it is with regret that I now worry that he may be deepening what looks more and more like a depression and may engineer so much spending, debt, and government control of the economy as to leave most Americans permanently less prosperous and less free.

Other Obama-admiring centrists have expressed similar concerns. Like them, I would like to be proved wrong.

[...]

But with the nation already plunging deep into probably necessary debt to rescue the crippled financial system and stimulate the economy, Obama's proposals for many hundreds of billions in additional spending on universal health care, universal postsecondary education, a massive overhaul of the energy economy, and other liberal programs seem grandiose and unaffordable.

[...]

The markets have also been deeply shaken by Obama's alarming failure to come up with a clear plan for fixing the crippled financial system -- which has loomed since his election four months ago as by far his most urgent challenge -- or for working with foreign leaders to arrest the meltdown of the world economy.

Perhaps President Obama will come to some agreement with foreign leaders on constructive action during the upcoming G-20 meeting in London.

Buyer's Remorse

From Jim Cramer's open letter to the White House yesterday:

I favored Obama over McCain because I thought Obama to be a middle-of-the-road Democrat, exactly the kind I have supported all my adult life, although I will admit to being far more left-wing during my teenage years and early 20s.

To be totally out of the closet, I actually embrace every part of Obama’s agenda, right down to the increase on personal taxes and the mortgage deduction. I am a fierce environmentalist who has donated multiple acres to the state of New Jersey to keep forever wild. I believe in cap and trade. I favor playing hardball with drug companies that hold up the U.S. government with me-too products.

But these are issues that we have no time for now, on the verge of a second Great Depression. This is an agenda that must be held back for better times. It is an agenda that at this moment is radical vs. what is called for. I am proud to have voted for the Obama who I thought understood the need to get us on the right path, and create jobs and wealth before taxing it and making moves that hurt job creation — certainly ones that will outweigh the meager number of jobs he’s creating.

Most important, I believe his agenda is crushing nest eggs around the nation in loud ways, like the decline in the averages, and in soft but dangerous ways, like in the annuities that can’t be paid and the insurance benefits that will be challenging to deliver on.

So I will fight the fight against that agenda. I will stand up for what I believe and for what I have always believed: Every person has a right to be rich in this country and I want to help them get there. And when they get there, if times are good, we can have them give back or pay higher taxes. Until they get there, I don’t want them shackled or scared or paralyzed. That’s what I see now.

The photo of Jim Cramer accompanied his essay on his Mainstreet.com site.

More on Japan

In yesterday's Financial Times, David Pilling wrote that many Japanese are pining for Japan's pre-industrial days, "Japan harks back to an age of innocence":

On a visit to Tokyo this week, on more than one occasion when I asked how Japan should tackle the economic crisis, my interlocutor turned with ninja-like alacrity to the topic of pre-Meiji Japan. The period before American warships forced the country open in the mid-19th century was regularly invoked as a prelapsarian idyll, a time when Japan did not have to deal with the grubby business of earning its crust in the world.

Eisuke Sakakibara, the former vice-finance minister indelibly branded Mr Yen, describes a country that was peaceful, orderly, unspoilt and friendly. “That was what pre-Meiji Japan was like. We should go back to that,” he says.

His invocation of a more innocent, pre-industrial age could easily be dismissed as idle chatter were it not for the fact that it keeps coming up.

[...]

There is now much talk of putting more emphasis on agriculture and de-emphasising the manufacturing industries on which postwar wealth was built. “Japan, having major strength in manufacturing, will probably suffer most,” says Mr Sakakibara, who argues that, even after this economic crisis subsides, the world will never return to previous levels of material consumption.

Japan’s farm industry is commonly regarded as heavily protected, but the Japanese worry that they only produce 40 per cent of their calorific requirements. Mr Sakakibara supports the DPJ’s proposals massively to increase subsidies to agriculture and to industrialise the family-run farming industry. He has been trying to persuade Toyota that cars are a dying industry and that it should turn its engineers on to farming efficiency instead. The era of just-in-time carrots could soon be upon us.

A Historical Perspective on China and Japan

Interesting letter to the editor in Wednesday's Financial Times:

Japan has been in the cold before, by the same rationale

Published: March 4 2009 02:00 | Last updated: March 4 2009 02:00

From Prof Arthur Waldron.

Sir, Japan’s allies have left it in the cold before (“A diplomatic feint that looks set to leave Japan in the cold”, Philip Stephens February 27), most notably after the Washington Conference of 1921-22, which saw the security treaty with Britain, fundamental to Japan, discarded, with a fine-sounding set of multilateral guarantees as substitute. The rationale then, as now, was the need to yield before the inevitable rise of China.

What happened? China entered an unexpected period of turbulence that threatened Japanese interests. Tokyo drifted for a while trying to work within the multilateral framework, but when it proved useless found a new compass in dictatorship at home and pre-emptive attack abroad, against China and eventually the US.

History does not repeat itself but it has lessons. One is never to sell short Japan, least of all as a power. Another is that all long positions on China should be carefully hedged.

Arthur Waldron,
Bryn Mawr, PA, US
Lauder Professor of International Relations,
University of Pennsylvania

The image above, of one of the Kongo Rikishi guardian statues at the Kofukuji temple in Nara, Japan, was pilfered from a Geocities site of what appears to be (judging by the flag) an Argentinian karate club.