It’s hard out here for a optimist!
March 31, 2006
Market Summary – 1st Quarter, 2006
In the early part of the 1980s, America was in a depressed mood. If you were around then, you remember what it was like. If you weren’t, or aren’t old enough to remember, it might be helpful to understand what the sense of the country was at that time.
The decade began with an unprecedented hostage crisis in Iran. Coming on the heels of the failure in Vietnam, the sentiment was growing that America was not the power that it had once been. Also on the international front, OPEC was pushing oil prices to record levels, draining the U.S. economy. The Soviets had invaded Afghanistan, prompting President Jimmy Carter to call for a boycott of the Summer Olympics in Moscow and denying Americans a summer distraction from all the despair.
Along with the oil price shock, the economy was in the doldrums. Interest rates were well into the double-digits and inflation topped 12% or more in 1979 and 1980.
America’s economy was also in the midst of a transformation that some perceived as the beginning of its downfall. The Midwestern manufacturing center of the country, namely the steel and auto industries, were fast turning into a rust belt filled with padlocked plants and unemployed workers. Japan was “eating our lunch” and, it was feared, taking over our country economically.
So it is fair to say that when it comes to dire and trying times for America, the early 1980s are a prime example. There was plenty of pessimism about the way things were going. This included many people writing off the idea of ever getting into the stock market.
Then what happened….
You know the rest of the story. With the exception of the crash of 1987 (we admit, not a tiny matter but in retrospect, a temporary blip), the stock market enjoyed a booming decade, and it didn’t really kick into gear until the middle of 1982. The S&P 500 rose by an average annual rate of 17.55% from 1980 through 1989, and by 18.21% per year from 1990 through 1999.
What else happened? Here are some of the major developments of the final two decades of the 20th century that the conventional wisdom failed to anticipate:
• Inflation tailed off and became a matter of little concern
• America, rather than losing power, became the world’s only superpower as the Berlin Wall and the Soviet empire collapsed
• Our manufacturing economy was replaced by an even stronger, more vibrant technology-based service economy
• Japan, rather than overtaking us as an economic power, went into an 18-year tailspin from which it only recently began to recover
• The benefits of stock investing came to light, and more Americans than ever participated in the market, creating significant wealth.
The lesson of the fear and loathing of the early 1980s is simple – it is always darkest before the dawn.
Back to the Future
This brings us to 2006. Perhaps more than any time since the early 1980s, there is a sense of foreboding about the direction of the country and the economy. There are concerns about matters that affect us currently. The Iraq war continues to cost lives and treasure without an end in clear view. Hurricane damage is proving to be a nightmare for a significant part of the Gulf Coast. Energy prices are again a big issue, reaching record levels.
But perhaps even more disconcerting than the sour sense many investors have about the present is the growing fear that our decline is imminent. Today’s conventional wisdom is that the next generation will actually be worse off than we are today.
Then there’s the onset of retirement for the baby boom generation, creating a “pension crisis.” It starts with Social Security’s future insolvency and continues with underfunded pension plans by corporations. From an economic standpoint, there is concern that America’s strength is fading as countries like China and India gain more economic power. From an environmental standpoint, there is a lot of talk about global warming and how that might literally change the landscape. To top it off, there seems to be a sense among some people that after all of the economic booms we experienced pre 9/11, we’re due for more challenges as a society.
In terms of our nation’s psyche, this might be the lowest point we’ve reached since the early 1980s, at least as far as having a confluence of events affect our outlook.
Presenting Dr. Jeremy Siegel
In the face of today’s gloomy outlook, we hoped to find somebody who could give a perspective that gives more people reason to share our generally favorable outlook for the world of money. We at MPMG are happy to present a special guest to our first ever speaker series – Dr. Jeremy Siegel, the Russell E. Palmer Professor of Finance at the Wharton School of the University of Pennsylvania. Prof. Siegel has become renowned as a researcher and writer on the financial markets. There may be nobody who has more carefully studied the history of the markets and what they tell us about the future.
At a time when the perception is that much is going wrong and our future prosperity is considered to be in doubt, Prof. Siegel has a different view? Just consider how he opens his latest book, The Future for Investors.
“The future for investors is bright,” writes Prof. Siegel. “Our world today stands at the brink of the greatest burst of invention, discovery and economic growth ever known. The pessimists, who proclaim that the retiring baby boomers will bankrupt Social Security, upend our private pension systems and crash the financial markets, are wrong.”
Now that isn’t just an optimistic outlook for investors – that’s downright exuberant! Prof. Siegel’s bullishness about the stock market is nothing new. Nevertheless, this isn’t just some pie-in-the-sky projection. Prof. Siegel backs up his assertion with a pretty good case, based on global demographic trends and his assessment of investment history. He contends that there is every reason to have faith in the stock markets and the potential profits they can generate for years to come.
The long run is what matters
Prof. Siegel gained notoriety in the booming era of the 1990s for his research and his book titled Stocks for the Long Run. In it, he made the case that stocks will generate returns that are far superior to those achieved by bonds or other types of investments, particularly if you have a long-term holding period.
Believe it or not, in 1994 when his book was published, there were still plenty of people with too little of their long-term assets in the stock market. That changed as the bull market of the 1990s gained steam. And what happened then, of course, was the bear market of the early 2000s.
Since then, the stock market has stabilized, though it shows no signs of being able to grow at a level close to what we enjoyed in the “irrational exuberance” days of the 1980s and 1990s.
Prof. Siegel is helpful at reminding us that what happens today or tomorrow or even six months from now in the stock market is less important than what we need to plan for years and even decades from now.
In his new book, he states that stocks overcome their perceived risk in comparison to bonds by better weathering the impact of inflation over extended periods of time. Prof. Siegel points out one of the most important distinctions between stocks and bonds:
Bonds – the income you earn represents a promise to pay dollars, not purchasing power.
Stocks – the gains they generate represent real assets, such as property, machines, factories and ideas. Over time, the price of these assets is likely to rise with inflation.
This is the reason why stock investors, by owning assets that can appreciate in value, have some protection against rising costs. Bondholders, by contrast, are paid only what they are owed by agreement of the bond issuer, regardless of how purchasing power might affect their return.
Bonds perform reasonably well during low inflation periods. When inflation is rising, it’s a different story. That’s not to say that inflation doesn’t take a toll on the stock market, but specific companies, that have the ability to adjust prices in order to keep profit margins intact, can still perform well – especially if you pay the right price for the stock in the first place.
So the case remains good for stocks, according to Prof. Siegel. Also in The Future for Investors, he does agree with an idea we have espoused for some time. Investing in an index isn’t the best answer. Not all stocks are created equal. A prime example he cites in the book is that the S&P 500 and Warren Buffet’s Berkshire Hathaway started in the same year, 1957.
$1,000 invested in the S&P 500 in 1957 grew to $130,700 in 2003
$1,000 invested in Berkshire Hathaway in 1957 grew to $51,356,000!
Why feel good about the future?
It can be summed up in one word – “globalization.”
Yes, America’s population is aging. That’s the case in other developed markets too, especially in Europe. This puts the social safety net for retirement at risk.
Many doomsayers also suggest that when baby boomers retire and start selling off their stock holdings, the market will go in the tank.
Prof. Siegel points out that this is looking at the problem by putting a wall around the border of the U.S. (or any other country that faces a similar issue). In truth, there are many countries with an expanding class of workers, and thanks to globalization, they are reaching a higher economic status. In fact, a number of developing nations are just beginning to come into their own economically.
Naturally, this makes us think about all of the jobs that have been exported to places like India. Many Americans view this as a scary proposition – perhaps adding competition that will affect our standard of living.
Prof. Siegel has a different view. He’ll talk in more detail about this at our speaker series event, but suffice it to say that he makes the case that rather than being our downfall, the emergence of these new economies will be our salvation. He suggests that a whole new breed of investors and an entirely new world of investment opportunities is being created by the growth of capitalism in overseas markets.
He has many more insightful investment views to share at our inaugural MPMG Speaker Series event on May 18th. We would like to invite all in the Minneapolis investment community who would like to attend be able to do so, however, seating will be limited so be sure to contact our offices at 612-334-2000, or contact your investment advisor, as soon as possible to request an invitation. There will be no admittance fee for this event. Signed copies of his latest book will also be available for purchase, with proceeds going to support Camp Odayin, a non-profit organization that provides residential camp, day camp and family camp for children with heart disease.
If you want to feel good about our financial future, and understand the reasons to feel that way, we suggest you attend Prof. Siegel’s presentation on May 18 and read his latest book, The Future for Investors.
Although the information in this document has been carefully prepared and is believed to be accurate as of the date of publication, it has not been independently verified as to its accuracy or completeness. Information and data included in this document are subject to change based on market and other condition. All prices mentioned above are as of the close of business on the last day of the quarter unless otherwise noted.
The information in this document should not be considered a recommendation to purchase any particular security. There is no assurance that any of the securities noted will be in, or remain in, an account portfolio at the time you receive this document. It should not be assumed that any of the holdings discussed were or will prove to be profitable, or that the investment recommendations or decisions we make in the future will be profitable. The past performance of investments made by MPMG does not guarantee the success of MPMG’s future investments. As with any investment, there can be no assurance that MPMG’s investment objective will be achieved or that an investor will not lose a portion or all of its investment.