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Will Stock Investors Go on a Buyers' Strike?

This article discusses two different perspectives on why investors might turn away from stocks:

- repaying government debt may cause future growth (and stock returns) to suffer.
- stock returns have already been anemic for the past 10 years.

Will Consumers Be a Lot Shorter on Cash in the Future?

There are many, many reasons these days to be extremely cautious in approaching where to invest your money when considering the years ahead.

We seem destined for a period of slower than normal growth, given that the monetary (i.e. Fed rate cuts) and fiscal spending programs that have been used copiously in the US to promote growth, are unlikely to be available for the foreseeable future. While the Fed may still have some other measures at its disposal, government spending will eventually be forced to wind down, mainly for political, if for no other, reasons. Already, further extensions to unemployment benefits have been tabled, meaning that that if sustained, much less money will be available for consumers to spend.

And likely, other blows to potential growth are on the horizon. Many experts now say it is only a matter of time before we start to see a gradual chipping away of the Bush era tax cuts, along with potential additional tax increases such as a national "value added tax" (i.e. sales tax). The winds of deficit cutting are already making their appearance in most major worldwide non-US economies and will, by necessity, reach our shores almost as certainly as the spilled Gulf oil. Our generous backstops of Social Security and Medicare are unlikely to survive in their current form, or at a minimum, become subject to greater taxation. (Look no further than France where the retirement age is highly likely to go up by 2 years.)

All of these likely changes, while necessary in that the governments (including at the state and local levels) have collectively used relatively poor planning in creating government spending levels without sufficient sources of revenue to fund them, can only mean that the societal safety nets provided by these benefits will be gradually eroded in the years ahead. Less income and benefits (and/or more taxes) translate into less money in consumer's pockets (and/or bank accounts), money that otherwise would have gone to purchasing power and contributing to corporate profits. Instead, we must pay back some of the debts that represent the prior willingness to spend, which government was presumably knowingly willing to do in exchange for future spending.

What will all of this mean for your investments? While nothing can be said for sure, it does appear that if growth will be less, returns in stocks may be less than otherwise as well. On the other hand, this may be somewhat offset by the fact that stocks have become considerably less overvalued than they were 5 or even 10 years ago. On balance, these factors are the reason why we continue to suggest that returns on stocks in the next 5 years or so are likely be somewhat less than "normal," but, in our view, still perhaps in the 5 or 6 to 8% range. And slower than normal growth also suggests that bonds can continue to be a decent, although not a great, investment.

While the above, along with imbalances around the world, means even higher risk in investing in stocks than "normal," with nothing assured, we still feel that stocks over the longer term will be a better place to invest than the remaining alternatives. But stocks cannot be for the faint of heart. Investors will need to take a deep breath and recognize the high degree of risk entailed. They must be able to focus on the long-term future potential rewards, and not on the potential paper losses that can easily be incurred along the way. Without such a state of mind, the seemingly endless battering that the news will likely inflict on investors' confidence level suggests that many more people may want to perhaps redefine themselves as "conservative investors," meaning to some they stay clear of stocks altogether.

Past Negative Returns May Also Lead to a More Conservative Investor

Ever since my Newsletter began publication in 1999, we have almost always gone against the grain in suggesting that the S&P 500 is not the "gold standard" for investors. Rather, we have maintained that by a) carefully selecting a portfolio of stock and bond funds, with a much broader diversification away from the Index's large cap stock blend and U.S.-based makeup, and b) occasionally adjusting your portfolio by shifting to those categories with the best forward-looking prospects, one could frequently do better than the Index.

When we started publication, the S&P 500 was indeed hard to beat, averaging yearly returns of nearly 19% over the prior decade. No other widely available fund category could match it, although funds narrowly labelled as Health, Biotechnology, Science, or Technology did manage to best it.

Contrast that with today's dismal decade-long returns: The Index averages a negative return of more than 1% per year. But this time, most other categories have indeed beaten it by small degree returning, we estimate, on average more than plus 1% per year. But, obviously, such returns are highly disappointing. In order to have done significantly better, one would have needed to have had a large exposure to small and mid-caps (but only those funds without a growth emphasis), and/or natural resources, real estate, and emerging market funds. Of course, bond funds have done better as well, although not extraordinarily so, with average yearly returns for all taxable funds of a little more than 5%.

So in looking back, our overall premise of finding better opportunities than as represented in many investors' portfolios by a high proportion of U.S. large cap funds, including S&P 500 Index funds, has been borne out over the last decade. But this is mainly the case to the extent that one was able to find a significant weighting in the aforementioned categories, and avoided those categories (including all Growth categories and non-emerging market International funds) that did not, on average, do better than the Index.

However, this itself proved to be a tall order to accomplish. Most investors tend to heavily weight large cap stock funds along with a varying exposure to broad international stocks, as opposed to small-cap, value, or emerging market stock funds, or bond funds. It should come as no big surprise, then, that not only most investors have not done well over the decade, but they have been provided with ample evidence that even over long stretches, stocks may be a far more risky proposition than they imagined.

Of course, the above figures assume a buy and hold approach and reflect a decade-long period. Our emphasis on making occasional allocation shifts may have helped over shorter periods in that it usually suggests selling/reducing exposure to a fund to capture past above average multi-year returns. The last 10 years had a myriad of opportunities to sell, given cyclical bull markets which eventually were driven lower with many built-up gains severely reversing course.

Here, though, is one of the most disappointing and discouraging aspects of stock fund investing over the last 3 and 5 years: The annualized returns of nearly -10% and -1% respectively for the S&P 500 have been pretty much equally bad for all categories of stock funds. (This is in contrast to the significantly different performances when considering the entire decade as described above.) This universally "blah" performance has been thanks to the bear market that started its descent in late 2007 but whose influence dominated the entire half decade. (During the earlier 2000-2002 bear market, some stock categories actually showed good gains which persisted in the years that followed.)

The bottom line? No matter how you adjusted your stock positions between categories over the last 5 years, there was little beneficial effect for relatively long-term investors. (Not so, though, if you shifted out of stocks into bonds which would have turned poor stock results into small to moderate gains. Exception: Over the last one year during which time stock returns were generally equal or better depending on the type of bonds chosen.)

While one can easily understand why some might use the above data as sufficient rationale for avoiding, pulling back from, or even closing out on investments in stocks, we advise most investors to cautiously stick it out. While our reasoning cannot be laid out with charts, data, economic analyses, or even a series of reassuring statements, we believe that overall the world remains essentially same, that is, subject to the same ups and downs as always. The vast majority of careful long-term investors down through the decades have had the opportunity to earn returns in the 8-9% range. And likely, the opportunity to make decent returns, or better, is increased for those investors who are willing to invest when it looks as if the bottom might drop out, or in other words, when the fear factor tends to be quite elevated.

For additional thoughts and our suggested Portfolios for moderate, aggressive, and conservative risk investors, see http://funds-newsletter.com.


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