WHY STOCKS STILL MATTER
The market has been hurt, but equities are still important.
If you are retired or nearing retirement, you may have recently directed more of your invested assets into cash, or into bonds, CDs, fixed annuities or other investments outside the stock market. That’s understandable. However, whether you are 65, 45 or 25, there is still a need to grow your money over time. Stock market investment gives you the potential for remarkable growth in a way few investment choices do. Here’s why stocks still matter.
You need to stay ahead of inflation. Yes, inflation is low right now, but it may not be later. From 1999 to 2008, the annual U.S. inflation rate averaged 2.83%. In the ten years before that, annual inflation reached as high as 5.39%.1 (Those over 40 can remember a period when inflation was considerably higher.) If your fixed-income investments are earning 3-4%, perhaps 3-4% annual inflation appears tolerable. But consider the accelerating costs of medical treatments and hospital stays. Consider that the tax code could change. Consider that the economy could be very different than it is now in a few years.
If you’re in your thirties or forties, it is not time to bail out. Can younger investors save their way to retirement on CDs and Treasuries? Attempting to do so may carry a severe opportunity cost in years to come. This is why financial advisors often counsel their younger clients to keep contributing to retirement plans and stay invested in the market in diversified ways. In the long-term, retreating from stocks could mean losing a lot of ground to inflation. In fact, a working paper from the National Bureau of Economic Research suggests a 95% chance of stocks performing 3-13% better than bonds over long time periods.2
While this downturn has really hurt upper-middle-class and upper-class investors who own substantial stock, it may offer a powerful silver lining for investors younger than 50 who adopt a long-term horizon. The stocks that they purchase in the coming years may appreciate much more than they might if the Dow were still above 14,000.
The market may be presenting you with extraordinary values. In early March, companies in the S&P 500 were trading at 10x profit earned over the past 12 months – that’s a price-earnings ratio (P-E) of 10, the lowest valuation on these companies in about 20 years.3
In terms of historical comparison, data from InvesTech research shows P-E ratios at 7 during the bottom of the 1973-74 bear, 7.7 at the end of the 1982 bear, and 12.8 after Black Monday and the fall 1987 market correction. (By contrast, the P-E ratio of the companies in the S&P 500 stayed around 30 at the low point of the 2000-02 bear market.)3 As bear markets end at some point, the current P-E of 10 is attractive. (Of course, P-E ratios could go even lower.)
Buffett: “Bad news is an investor’s best friend.” Last October, in a New York Times op-ed piece titled “Buy American – I Am”, Warren Buffett made just that statement. He conceded that “in the near term, unemployment will rise, business activity will falter and headlines will continue to be scary” – and this was precisely why he was buying American stocks for his personal portfolio.
In Buffett’s opinion, “fears regarding the long-term prosperity of the nation’s many sound companies make no sense. These businesses will indeed suffer earnings hiccups, as they always have. But most major companies will be setting new profit records 5, 10 and 20 years from now.”
Buffett states that while people who hold cash equivalents may now feel comfortable, “they shouldn’t. They have opted for a terrible long-term asset, one that pays virtually nothing and is certain to depreciate in value.” He thinks (like some economists) that the current federal counterattack on the financial crisis could likely increase inflation pressures and “accelerate declines in the real value of cash accounts.”4
Some stock market analysts see a net gain in 2009. In late February, Goldman Sachs analyst David Kostin projected that the S&P 500 would end 2009 at around 940 – lowered from a previous projection of 1,100, but still very bullish.5 The National Association of Business Economics surveyed 47 top economists in the first quarter of 2009, and even with the market descent to open the year, their consensus was that the S&P 500 would end 2009 at around 975 – which would be approximately an 8% gain for the year and quite a surge from current market levels.6
It’s wise to be well-diversified. Diversification is not only smart, but sane in this bear market. When your investments are appropriate for your life stage and selected to work for your goals, you have the confidence of knowing you have made wise choices. Consult your financial advisor to determine what choices suit your preferences, goals and lifestyle.
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— J. Michael Stolp — My Info — See Disclaimer |
These views should not be construed as investment advice. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. The publisher is not engaged in rendering legal, accounting or other professional services. If other expert assistance is needed, the reader is advised to engage the services of a competent professional. Please consult your Financial Advisor for further information.
Citations.
1 inflationdata.com/inflation/inflation_Rate/historicalinflation.aspx
inflationdata.com/inflation/Inflation_Rate/HistoricalInflation.aspx?dsInflation_currentPage=1 [3/4/09]
2 papers.nber.org/papers/w6207 [2/98]
3 usatoday.com/money/markets/2009-03-04-are-stocks-cheap_N.htm [3/4/09]
4 nytimes.com/2008/10/17/opinion/17buffett.html [10/17/08]
5 cnbc.com/id/29429549 [3/2/09]
6 money.cnn.com/2009/02/23/news/economy/nabe/index.htm [2/23/09]
