The Dow Jones Industrial Average is currently at about the same level it was in early 1998. This means that, ignoring dividends, investors have earned nothing in 10 years.
In March 1999, immediately after the Dow broke above 10,000 for the first time, James Glassman and Kevin Hassett published their now infamous op-ed in the Wall Street Journal called Stock Prices Are Still Far Too Low. They argued that investors were overestimating the risks associated with investing in stocks. They argued that stocks were no more risky than a government bond.
Perhaps to demonstrate just how bullish they were on stocks, they also published a book that same year titled, Dow 36,000. They weren't trying to imply that the Dow should reach 36,000 some day. No, they were insisting that the Dow should be at 36,000 right now (i.e., in 1999).
Their point was that investors were wrong to think that stocks were risky simply because stocks were volatile. Because history showed that stocks outperformed bonds over the long term, the authors argued that stocks were really no more risky than bonds. In fact, they argued that the appropriate risk premium for stocks is zero.
This reminded me of a debate I had many years earlier about mortgages. My opponent at the time was arguing that the best mortgage is always the one with the lower interest rate. My point, however, is that cash flow must also be considered. A one-year interest free mortgage is clearly cheaper than a 30-year mortgage at 6%, yet there aren't many borrowers who have the kind of cash flow needed to service that one-year mortgage.
Likewise, stocks have outperformed bonds over the long term and may continue to do so in the future. But not all investors can stomach the volatility. Investors have cash flow needs. They can foresee some of those needs, but they can't foresee them all. This is why investment advisors never tell their clients to put all their money in stocks even though they believe stocks will do well over the long run.
Stocks are not risk free, but from a long-term perspective, they are probably less risky today than they were when the Dow was at 14,000. Yet at 14,000, investors were happy to buy stocks--many using lots of margin. But now, most investors are simply too scared to buy. Who knows when (if ever) the Dow will hit 36,000, but it's a good bet that it will hit 10,000 again--perhaps sooner than we think.
Friday, January 16, 2009
Friday, January 09, 2009
Beware the U.S. Congress
There are plenty of conflicts and problems going on around the world, each vying for the attention of global investors. The war between Israel and the Palestinians is currently on the front burner. It's a conflict that threatens to pull in Iran, which continues in its race toward a nuclear weapon. The wars in Iraq and Afghanistan are still going on. Terror attacks in Mumbai threaten to break the shaky peace between Pakistan and India. And Russia is flexing its muscles by threatening former Soviet republics and restricting the flow of natural gas to Ukraine and Western Europe.
Given all these seemingly intractable problems, which poses the biggest risk for investors? According to Ian Bremmer of the Eurasia Group, the top risk of 2009 is financial regulation in the United States and the rising power of Congress.
Bremmer reminds us that following our last financial crisis, Congress gave us the Sarbanes-Oxley act. We are likely to get something much more onerous this time. The bottom line is that there will be considerably more regulation. Congress will try to regulate everything from the rating agencies to complex financial securities. It will also reform the regulatory agencies. The risk is that Congress may make things worse by delivering bad regulation or simply going overboard in a manner that prevents innovation.
Bremmer also worries that government is getting involved in the actual management of private enterprises. It already holds large stakes in publicly-traded companies, and there is talk of a car czar to oversee the automobile industry.
Finally, Bremmer is concerned that fiscal policies meant to spur the economy may fail. Infrastructure spending, for example, may end up doling dollars to favored pork barrel projects instead of targeting the most worthy programs.
The Eurasia Group is perhaps the best political risk consultancy in the world. It certainly is an ominous sign that this highly-respected firm thinks the U.S. Congress poses the greatest risk to investors in 2009.
Given all these seemingly intractable problems, which poses the biggest risk for investors? According to Ian Bremmer of the Eurasia Group, the top risk of 2009 is financial regulation in the United States and the rising power of Congress.
Bremmer reminds us that following our last financial crisis, Congress gave us the Sarbanes-Oxley act. We are likely to get something much more onerous this time. The bottom line is that there will be considerably more regulation. Congress will try to regulate everything from the rating agencies to complex financial securities. It will also reform the regulatory agencies. The risk is that Congress may make things worse by delivering bad regulation or simply going overboard in a manner that prevents innovation.
Bremmer also worries that government is getting involved in the actual management of private enterprises. It already holds large stakes in publicly-traded companies, and there is talk of a car czar to oversee the automobile industry.
Finally, Bremmer is concerned that fiscal policies meant to spur the economy may fail. Infrastructure spending, for example, may end up doling dollars to favored pork barrel projects instead of targeting the most worthy programs.
The Eurasia Group is perhaps the best political risk consultancy in the world. It certainly is an ominous sign that this highly-respected firm thinks the U.S. Congress poses the greatest risk to investors in 2009.
Cut Property Taxes Now
According to the S&P/Case-Shiller 20-city Home Price Index, housing prices peaked in July 2006. They have fallen 23% through October 2008. With employment falling, housing prices will no doubt go lower in coming months.
If there is any good news in this, it is that the affordability index is improving. This index tries to give us some sense of how affordable the median priced house is for the median income family. In addition to housing prices, the affordability index considers mortgage rates, which have also come down largely due to government intervention.
Unfortunately, the affordability index ignores an increasingly important cost of home ownership: property taxes. Prospective home buyers in many parts of this country, especially the Northeast and Midwest, must pay close attention to this cost before signing on the bottom line. For many homeowners the monthly outlay for property taxes now rivals their monthly payment toward principal and interest.
This economic recession we are currently struggling through was largely brought on by the collapse of housing prices. The recession won't end until housing prices stabilize. Lower mortgage rates are certainly helpful, but reducing property taxes would go a long way to provide a much needed boost to the housing market. Obviously, the federal government has no role here. It is up to local municipalities to cut property taxes. Like the rest of us, they need to trim their budgets and live within their means. Otherwise, more neighborhoods will be plagued with vacant and foreclosed homes.
If there is any good news in this, it is that the affordability index is improving. This index tries to give us some sense of how affordable the median priced house is for the median income family. In addition to housing prices, the affordability index considers mortgage rates, which have also come down largely due to government intervention.
Unfortunately, the affordability index ignores an increasingly important cost of home ownership: property taxes. Prospective home buyers in many parts of this country, especially the Northeast and Midwest, must pay close attention to this cost before signing on the bottom line. For many homeowners the monthly outlay for property taxes now rivals their monthly payment toward principal and interest.
This economic recession we are currently struggling through was largely brought on by the collapse of housing prices. The recession won't end until housing prices stabilize. Lower mortgage rates are certainly helpful, but reducing property taxes would go a long way to provide a much needed boost to the housing market. Obviously, the federal government has no role here. It is up to local municipalities to cut property taxes. Like the rest of us, they need to trim their budgets and live within their means. Otherwise, more neighborhoods will be plagued with vacant and foreclosed homes.
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