The Long View Seems Closer

Since I last wrote, the markets have hit wrenching new lows. The Dow Jones Industrial Average has dropped below 7,000 for the first time since 1997. Day after day, we read dreary headlines. They tell us that the banks are going to fail; job losses are on the rise; unemployment is rising faster than anticipated. The auditors for General Motors say they have "substantial doubt" about GM's ability to survive outside bankruptcy. One in five people with mortgages owe more than their home is worth. In short, these are frightening times.

These headlines come on top of a decade of decline for stocks. From 1998 through 2008, the S&P 500's average annual return was -1.4 percent, and this span includes one year, 1999, when the market was up 35 percent! After a decade of lower real wage growth, dropping stock prices, and two or three wars, pessimism has a right to rule.

On the other hand, indications in favor of holding continue to be real. Pequot, a money management firm, points out that in each of the cases when the market's prior ten years reported less than 2 percent average annual gains, the returns in the following decade were significant, averaging 10.7 percent a year. Morningstar's Ibbotson Division has published the dangers of pulling your money out on stock market drops, or market timing.

According to these studies: for the 83-year period from 1926-2008, a hypothetical $1 investment made at the beginning of 1926 would be worth $2,049 by year-end 2008. But if the investor had missed the best 40 months, that same $1 would be worth $20.25. That's a big difference, even worse than just staying in Treasury bills, which would have grown to $20.53.

For the 20-year period from 1989-2008, a hypothetical $1 investment made at the beginning of 1989 would be worth $5.04 by year-end 2008. But if the investor had missed the best 10 months, that same $1 would have grown to only $2.16. Again, Treasury bills did better than timing. They returned $2.30. That is why you keep hearing, "hold the course."

What should the stock market be worth today? To a certain extent the investment in stock markets is an investment in the growth of a nation. Today the stock market is at 1997 levels. Back then, according to the CIA World Factbook, our Gross Domestic Product (GDP) was $7.6 trillion. In 2008, however, it had grown to almost double that at $14.6 trillion. Even with our GDP shrinking at the moment, the fact that the GDP is still twice its 1997 levels is an awfully big disconnect from where the market is priced today.

For a long time now, I have been saying that the first steps to a stronger market will be real leadership from Washington. The President and his policies continue to be very popular, and he is using this political capital wisely. I noted that the proposed budget cuts Pentagon spending and the war on drugs. These sink holes have long been on autopilot and redirecting funds to food stamps represent real fiscal responsibility progress. Mark Zandi, chief economist of Moody's Economy.com, gave testimony before the U.S. House Committee on Small Business on July 24, 2008 in which he stated that a $1 increase in food stamp payments boosts GDP by $1.73. A recent Wall Street Journal poll found that 41 percent of Americans say the country is going in the right direction. That is up from12 percent before the election.

Our new government's efforts have already saved some jobs, saved some homes and have softened the blow of the credit crisis. The one big disappointment, however, has been that the Securities Exchange Commission continues in its reluctance to squash the mechanisms for speculation. This omission was partially addressed this morning, as the Federal Reserve chairman Ben Bernanke speaking to the Council on Foreign Relations stepped in where the SEC had failed. He said, "Strong and effective regulation and supervision of banking institutions, although necessary for reducing systemic risk, are not sufficient by themselves to achieve this aim," and that the financial system needed to be regulated "as a whole, in a holistic way." Markets responded euphorically.

Perhaps the SEC is finally ready to act more broadly. This morning Representative Barney Frank (Democrat from Massachusetts) reported he expects the uptick rule to be restored very soon. "I've spoken to Chair (Mary) Schapiro of the SEC. I am hopeful the uptick rule will be restored within a month." It's about time.

With regulation coming, and far more sensible spending by Washington, the groundwork is set for recovery. The stock market is a forward looking creature and given even a bit of encouraging economic or financial news, it will move higher. Meanwhile, I feel it difficult to build the case for selling and urge those who are so inclined to go back and re-read the Morningstar Ibbotson figures quoted above.