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Investing For the Medium Run
Old 03-10-2010, 09:23 AM   #1
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Investing For the Medium Run

I posted this over at the Bogleheads board but thought the folks here might have more pertinent commentary being RE oriented.

Interesting article in The Economist magazine, Feb 27th, Buttonwood column, entitled The Very Long View. In the article are some facts like the British equity prices reached peaks in 1906, 1936, 1968 and 1999 and the US in 1928, 1968 and 1999. And in 1974 British equities traded for just 30% of their real value at the end of the 19th century. There are other observations on Japan (Share prices in Tokyo are still trading at only a quarter of their 1989 peak) and on US real estate prices (in real terms, an index of American house prices rose from 100 in 1890 to 110 by the end of the 20th century. By the end of 2006, at the top of the housing boom, the index had reached 199). And, according to The Economist, the driver of the current decline is demographics.
OK, so this is more sophisticated doom & gloom than some financial crackpots. But the question I always asked myself was what would a somewhat clever working stiff in Japan in the 1960s through the 1980s do to optimize their investments? I suppose I could add British investors since the 1900s. All as a guide to what should I be doing now. Seems like a lower percent in equities is warranted and probably a good percentage (50%+?) in international stocks.
The figures in the article did seem to support that equities could be good in the long term but the long term is 30 year cycles and I, being 60, don't really have a 30 year investment horizon and demographics are not in favor of the boomers. But right now, cash & fixed income offer some pretty bleak returns. I manage my elderly mother in law's assets and I keep those very short. I also manage a fraternal organization assets which has 100 year+ horizon, so they can go very long but I figure on wanting to maximize my spending over the next 10 to 15 years, what to do?
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Old 03-10-2010, 09:36 AM   #2
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When you figure it out let me know because I wanna do the same

Historical data seems suspect to me these days.

Everything world wide is electronically tied together and we are headed head long into the "New world order"....

Computers get more and more powerful and plentyful, I believe that changes the game going forward...

Weather or not we will be better off remains to be seen...
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Old 03-10-2010, 10:15 AM   #3
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And, according to The Economist, the driver of the current decline is demographics.

. . .

Seems like a lower percent in equities is warranted and probably a good percentage (50%+?) in international stocks.
All of the developed world has worse demographic trends than the U.S. does. The U.S. still has pretty decent fertility and decent immigration that keeps the population growing and young (at least compared with Europe & Japan).

Many emerging market countries have much better demographics, but one has to wonder if its already a little late to crowd in to that trade. China is OK for now, but their "One child policy" could come back to bite them a couple decades out.
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Old 03-10-2010, 10:18 AM   #4
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Many emerging market countries have much better demographics, but one has to wonder if its already a little late to crowd in to that trade. China is OK for now, but their "One child policy" could come back to bite them a couple decades out.
Well, history shows that when a nation becomes more affluent and more educated, their birth rate declines sharply; I think that's pretty much been true everywhere. So if economic development in China continues long enough, the birth rate may take care of itself without any need for government coercion like the one child policy.
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Old 03-10-2010, 10:34 AM   #5
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The OP brings up some interesting issues...

To paraphrase, What will happen to portfolios as all of the boomers start liquidating assets in retirement. What will happen to portfolios as taxes rise significantly to cover growing debt and growing entitlement burdens. What will happen to portfolios as peak oil, global warming run their course. What will happen to portfolios as the rise of emerging economies displace developed economies. Add in the demographic issues and you've got a big picture of not good !

These certainly are some troubling issues to contemplate.
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Old 03-10-2010, 11:18 AM   #6
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What will happen to portfolios as the rise of emerging economies displace developed economies.
In your list of potential concerns, I see this one as a large potential mitigant. Economic growth is not a zero sum game. This past century the U.S. economy was the engine of world growth. The next century will very likely be propelled forward by billions of people lifing themselves from poverty . . . that's good on many, many levels.
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Old 03-10-2010, 11:20 AM   #7
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I don't think registration or subscription is required to view the article:
Buttonwood: The very long view | The Economist
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Old 03-10-2010, 11:33 AM   #8
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In your list of potential concerns, I see this one as a large potential mitigant. Economic growth is not a zero sum game. This past century the U.S. economy was the engine of world growth. The next century will very likely be propelled forward by billions of people lifing themselves from poverty . . . that's good on many, many levels.
True, but nevertheless, while global economic growth is a rising tide which generally lifts all boats (at least where there is some semblance of free-market economics), it lifts some more than others. At this point I think the boats of the "developed world" are anchored down in debt and high labor costs to the point where they will rise less than the smaller, swifter boats not so encumbered by a legacy of overspending and overpromising.
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Old 03-10-2010, 11:43 AM   #9
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Good summary, thanks for posting this OP.

This has to be true, even without the demographic explanation. Why? Because shares are not tickets on an airplane, they are businesses with definite market and financial constraints on the amount of cash flow they can produce. So valuation counts, over several market cycles.

Some people consiously or unconsciously are speculating, not really investing, even if their intended holding period is fairly long. This has worked very well for the skilled or lucky ones- think all those who got rich on the dotcom mania.

I think about this often, and I don't see any easy routes around the investment for retirement problem. I do think that our government, and probably most governemnts around the world will inflate as much as they feel they have to to remedy high unemployment and financial and business distress. So it is quite possible that while real returns going forward will be poor to awful, nominal returns to equities may be better than most alternatives.

A sure loser is long term non-indexed debt.

A note on inflation. Mr. Bernanke before he became chairman addressed quibbles that the government perhaps did not have the power to create inflation with this proposition:

1) Any government which controls its own currency can create any amount of it at essentially no cost.
2) If prices denominated in the currency didn't rise, the government could purchase all the assets and goods and services available on that economy.
3) This could not happen.
4) Therefore the US or UK can always produce inflation, merely by increasing the money supply (currency if need be)
5) Q.E.D.

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Old 03-10-2010, 11:51 AM   #10
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4) Therefore the US or UK can always produce inflation, merely by increasing the money supply (currency if need be)
In the long run, yes. In the shorter term, if the velocity of the increased money supply keeps getting slower and slower -- if banks don't lend, if businesses and consumers use cash flows to pay off debt or save and the overall sentiment leans toward debt reduction and/or cash hoarding -- inflation won't necessarily occur. It's when the increased money supply is actively pursuing the same fixed basket of goods and services when inflation rears its ugly head. Merely printing the money isn't enough to induce inflation; it needs to change hands through commerce to do that.

Printing money tends to be inflationary. Increased defensive deployment of new capital through debt paydowns and savings tends to be deflationary. IMO, so far the latter has counteracted the former such that there has been little reported inflation (CPI questions notwithstanding)... but if at some point more of that increased money supply is actively looking to buy stuff, *then* inflation is the result.
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Old 03-10-2010, 11:59 AM   #11
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A sure loser is long term non-indexed debt.
But inflation is not the only path. The other alternative to our debt burden is fiscal austerity, which is gaining political support. That path leads to deflation where long, non-idexed bonds reign supreme.

So what is one to do?
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Old 03-10-2010, 11:59 AM   #12
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In the long run, yes. In the shorter term, if the velocity of the increased money supply keeps getting slower and slower -- if banks don't lend, if businesses and consumers use cash flows to pay off debt or save and the overall sentiment leans toward debt reduction and/or cash hoarding -- inflation won't necessarily occur. It's when the increased money supply is actively pursuing the same fixed basket of goods and services when inflation rears its ugly head. Merely printing the money isn't enough to induce inflation; it needs to change hands through commerce to do that.

Printing money tends to be inflationary. Increased defensive deployment of new capital through debt paydowns and savings tends to be deflationary. IMO, so far the latter has counteracted the former such that there has been little reported inflation (CPI questions notwithstanding)... but if at some point more of that increased money supply is actively looking to buy stuff, *then* inflation is the result.
All good arguments. But as Bernanke implied, eventually even the most clueless among us will be running to the store with our wheelbarrows.

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Old 03-10-2010, 12:32 PM   #13
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. . . and creating inflation in a liquidity trap isn't as easy as it sounds. Japan hasn't been able to do it. Or at least hasn't had the will to do it.

Quote:
Masaaki Shirakawa, BoJ governor, said on Tuesday the impact of Japanís five years of quantitative easing between 2001 and 2006 "was very limited in terms of whether it stimulated peopleís activity and resulted in an increase in prices".

Policymakers concede that the bank could create inflation if it bought enough bonds or used another unconventional policy, such as creating money to buy dollars or real estate, but judge that the risks are too large.

"The purchase of government bonds is just like injecting morphine into the dog," says Teizo Taya, a former member of the central bankís policy board who is a special counsellor to Daiwa Institute of Research. "All of a sudden the dog will jump and start running," he says, but the danger is an overdose.
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Old 03-10-2010, 03:25 PM   #14
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. . . and creating inflation in a liquidity trap isn't as easy as it sounds. Japan hasn't been able to do it. Or at least hasn't had the will to do it.
Yes; though my judgment is that Bernanke understands how, and will do it if he feels that the stakes as he sees them are high enough. His little study problem shows what is to me unassailable logic. And he isn't called Helicopter Ben for no reason.

Anyway, everyone has to make his own assessment of the situation and his own plan of how to deal with it. Nothing is guaranteed.

Ha
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Old 03-10-2010, 04:07 PM   #15
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His conclusion sounds similar to something I recently posted.
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The bad news is that the demographic maths imply that equity valuations will continue to fall until the middle of this decade. The news is even worse for government bonds. A similar model suggests that yields in both America and Britain are heading for 10% by 2020.
So demography drives investment fashion, and fashion determines valuations. In turn the long-term return is crucially dependent on the starting valuation. American equities now offer a dividend yield of just 2%, less than half the long-term average. Investors should remember that salutary statistic whenever they are tempted to get too bullish.
From the Pension thread.
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One of the big concerns for me how do we get to an 8% average return, given the current bond and stock markets. Bonds have a had great 30 year run as interest rates have plummeted from the double digit range. A big portion of bond returns came from capital gains. Given the current interest I don't think it is mathematically possible (baring a depression) for bonds to have another 10 or 30 year period like the last one. The pension/insurance/private equity/hedge fund manager and individual investor all face the same challenge. If you have 30-60% of your assets in fixed income and we know those returns going forward are going to be less, it requires stocks to have double digit returns. Considering the remarkable rally (at least some of which makes sense compared to winter 2008/spring 2009 market levels) we have had in the last year is that a realistic assumption?
I think a big part of the problem for returns going forward is the ratio of time people worked to be retired has changed dramatically and is slated to change even more dramatically as boomer's retire. 50+ years ago the average person start working at 17 continue working until 65 so 48 years, he then lived for another 8 years, so the ratio of working years to retired years was 6x
Now days, lots of people don't start working until after college say 22 retire a few years early say 62 and have worked for only 40 years and the life expectancy for 62 year old is over 20 years. So the ratio for working to retirement is only 2x.

In addition to the well understood problem with pension, social security etc. I think a secondary problem is that the relative value of labor vs capital has changed t. Labor was much more plentiful than capital 50 years ago, now with globalization enabling capital to flow easy and lots of retirees the reverse is true. Of course right now demand for both labor and capital is weak so we see very low prices for both...
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Old 03-10-2010, 04:27 PM   #16
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Yes; though my judgment is that Bernanke understands how, and will do it if he feels that the stakes as he sees them are high enough. His little study problem shows what is to me unassailable logic. And he isn't called Helicopter Ben for no reason.
True. And there is one major difference between Japan and the U.S. that might argue for a more aggressive Fed. Most of Japan's debt is held by Japanese citizens whereas an increasing portion of U.S. debt is held externally. Inflation harms lenders for the benefit of debtors. That seems like a good solution when your debt is held externally but maybe more difficult when you're hurting your own citizens.

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Anyway, everyone has to make his own assessment of the situation and his own plan of how to deal with it. Nothing is guaranteed.
So if you think equities are overvalued and bonds are a "sure loser" where do you put your money?
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Old 03-10-2010, 09:03 PM   #17
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So if you think equities are overvalued and bonds are a "sure loser" where do you put your money?
There's that old Churchill quote, "democracy is the absolute worst system of government in the world - except for all the others".

Maybe the investing parallel would be, "Equities are the absolute worst asset class - except for all the others"
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Old 03-10-2010, 09:37 PM   #18
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There's that old Churchill quote, "democracy is the absolute worst system of government in the world - except for all the others".

Maybe the investing parallel would be, "Equities are the absolute worst asset class - except for all the others"
I tend to prefer a mixture of equities and real estate for the longer term.

If people believe that there are no asset classes that will provide positive real rates of return, the rather ugly conclusion is that we will need to either (i) work longer or (ii) retire on less or (iii) take up extreme sports.
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Old 03-10-2010, 11:03 PM   #19
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So if you think equities are overvalued and bonds are a "sure loser" where do you put your money?
I do think there is not much around now, in the sense of entire asset classes that offer a good risk-reward picture. Jeremy Grantham, who has a very good validated record, feels that "quality stocks" are pretty good though not outstanding at today's levels.

My response to this environment is to continue to hold some quality dividend paying stocks, some MLPs and oil and gas passthroughs, some TIPS and I-Bonds, and a whole lot of CDs and cash equivalents. Nothing lasts forever, and a scarcity of opportunities today may become a cornucopia tomorrow. My task is to last until tomorrow.

Sometimes we forget that you can last a very long time just by taking refuge when things appear to be not very promising. Today's dilemma is that inflation could break out at anytime, and reach any level. So what we want is investments that would thrive in an inflationary environment, but would not get killed in a prolonged environment like today's.

My approach is to avoid guaranteed losers in an inflationary environment. For me that means absolutely no non-indexed long bonds.

I want to do well in inflation, and survive in other conditions. I am willing to forgo upside during deflation, as I think a true prolonged deflaion is unlikely. Nevertheless, I don't want guaranteed losers in a deflationary enviromnment either. Visibility is just not good enough to leave that whole flank undefended.

TIPS are not cheap, but they survive deflation and they thrive in inflation. Some thought should be given to selection of duration, buying only new issues, etc. Finding cheap, well financed stocks is less secure, but may work. Cash may do very well, as once the inflation genie is out of the bottle short rates will incease, though perhaps not to a level to give a positive real return. The beauty of cash is that you can change your mind without penalty.

Quitting work early is risky, so if we want to do it we should realize what we may encounter.

Ha
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Old 03-11-2010, 08:13 AM   #20
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In reality, the only investment that looks even remotely attractive now are steady, blue-chip dividend stocks with long-term histories of annual dividend increases. Everything else looks a little weak now, but things can turn on a dime so it remains as important as ever -- maybe *more* important than ever -- to remain diversified.
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