This article is a guest contribution by James Kwak, from Baseline Scenario.
The week between Christmas and New Yearās is probably a good time to throw out half-baked ideas on topics I donāt know much about.
First, thereās been a lot of talk about the ālost decadeā for stocks. The S&P 500 is below where it was a decade ago. Dividend yields bring you back up to break-even (the Vanguard Total Stock Market Index Fund had average annual returns of 0.18% for the ten years through the end of November, and thatās after about 0.1% in expenses), but inflation sets you back a couple of percentage points per year. (Vanguardās S&P 500 index fund, however, was negative over those ten years.) James Hamilton, drawing on data from Robert Shiller, has some thoughts on why the stock market did badly; the fundamentals were so-so, but the big factor was that valuations were at their historical peak at the beginning of the decade.
For me, the worrying thing about investing in stocks is not specifically the high price-earnings ratio. Itās the fact that in the 1990s, everyone started saying that stocks were the best long-term investment, because āover any thirty-year period ever stocks do better than any other asset class.ā Thatās not a direct quote, but Iām sure you can find hundreds that are virtually the same. There are two problems with this statement. The first is that itās assuming the future will be like the past. But the bigger problem is this: if everyone thinks that X is the best long-term investment, then it probably isnāt, in part because enthusiasm about X will drive the price of it up. I believe people were saying roughly the opposite in the late 1970s, and look what happened in the next twenty years.
That said, Iām no investment genius, and I have a fair proportion of my money in equity index or near-index funds. But the general point is that when everyone agrees on an investment strategy, they are probably wrong.*
Second, thereās been a lot of China boosterism in the past year or so, as the Chinese economy has returned to growth and its stock market has soared. The Times had an article today on the topic. Iām far from an expert here, but wasnāt the government basically ordering state-owned banks toĀ lend money cheaply and without asking too many questions? Arenāt Chinese economic statistics so bad that economists use electricity consumption as a proxy for GDP? Havenāt we seen this movie before all over emerging markets around the world?
I think some of the U.S. press coverage of China reflects our pessimism about ourselves; in that sense, it reminds me of the idolization of Japan that took place in the 1980s. Of course, there are huge differences. The Chinese economy has nowhere to go but up, and with over 1.3 billion people its economy will surpass ours in gross output in my lifetime. (On a per capita basis, though, I donāt think that will happen in my daughterās lifetime, even if there is a Chinese immersion charter school down the road here in Western Massachusetts.) But just as the United States is not on the brink of world-historical disaster, so everything is not perfect in China.
* Whatās the right grammar here? I know āeveryoneā is singular, but are you really supposed to say āwhen everybody agrees on an investment strategy, he is probably wrongā?
James Kwak is a former McKinsey consultant, a co-founder of successful software company, and currently a student at the Yale Law School.Ā He is not, never has been, and never will be a member of the Yale Law Journal. However, on December 11, 2009, he was named Grand Heresiarch of the Ancient, Hermetic, and Occult Order of the Shrill by Brad DeLong. He is a co-founder of The Baseline Scenario.