Are Stocks Still a Good Investment?

The latest jobs report, on Friday, which revealed no net job growth, confirms what a lot of people suspected: that the economy is stalled out. The prospects for the future are guarded, at best. Businesses don't want to hire. Consumers don't want to spend. Political pressure from the right prevents further large scale governmental intervention. Except possibly by the Fed, and its options don't look appealing. The most it can hope for is that further money printing might puff up the financial markets and create a "wealth effect" to spur spending by the rich. But Tiffany, Hermes and Louis Vuitton don't employ that many people in America's heartland, so more money for the rich won't do much to revive the overall economy.

Are stocks still a good investment? Whatever the Fed does, it will have only a short run effect. QE2, announced a year ago, is already dissipating. If the Fed does QE3, it will likely have little or no impact beyond the months the Fed is running the money printing presses. After that, we'll probably stagnate again.

Japan's experience suggests pessimism. In the late 1980s, Japan had a real estate and stock market bubble that, if you can believe it, was more extreme than America's recent bubbles. Real estate prices went so high that people were taking out 100 year mortgages to pay for their homes. When it comes to encumbering future generations, that takes the cake.

The Nikkei 225 average peaked at 38,916 on December 29, 1989, and then popped a la Dow Jones Industrial Average circa 1929-1933. It eventually dropped below 8,000 (not a typo; we're talking a belly flop of more than 80%), and now putters around the 8800 level. Adjusted for inflation, that means the Nikkei 225 is still almost 80% below its all time peak. A minus 80% return for over 21 years is, no matter how you look at it, pretty stinky.

An example closer to home of the deleterious effects of an asset bubble is the Nasdaq stock market. The Nasdaq index peaked at 5,048.62 March 10, 2000. Since then it has dropped as much as 70% or so. It has never recovered more than half its peak value, after adjustment for inflation. Today, it trades around 35% of its 2000 peak, on an inflation-adjusted basis. A minus 65% return for 11 years is also pretty stinky.

The performance of other U.S. indexes isn't as bad as the Nasdaq. After adjustment for inflation, the S&P 500 trades around 54% of its all time peak on March 24, 2000 of 1527.46. The Dow Jones Industrial Average trades around 70% of its all time peak on April 11, 2000 of 11,287.08, after adjustment for inflation. Nevertheless, all of the major indexes are significant losers over the past 11 years.

Japan's government did a lot of the things the U.S. government has been doing since the 2008 financial crisis--deficit spending, money printing, zero interest rates, keeping downward pressure on its currency. None of it revived the economic locomotive that was the Japanese economy during the 1970s and 80s (although these measures may have prevented things from getting worse). The Japanese government protected jobs by keeping zombie corporations and zombie banks on life support. After ten or more years, the Japanese government began to eliminate zombie businesses. By the time it was done, however, the Japanese consumer was thoroughly beaten down, and China and other Asian nations had muscled into the export markets that Japan had previously dominated. While Japan remains a wealthy nation with a large export sector, it has limited potential for growth. Its stock market may not ever, in a time relevant to anyone reading this blog, recover its luster.

What of U.S. stocks? Economic growth is one factor crucial to future stock values--growth in America and growth overseas where U.S. corporations have markets. At this juncture, that's anyone's guess. Add to the mix downward pressure from Baby Boomers (in Europe and Aisa, as well as America) selling stocks to finance their retirements, and stocks appear to be a speculative bet. It is true that, after the 1929-33 crash, stocks recovered to about 50% of their pre-crash value after 21 years. But the enormous stimulus of wartime spending for the Second World War, plus the fact that America had most of the world's functioning industrial base immediately after the war, account to a large degree for that partial recovery.

Or course, not being in stocks means missing market upswings. If you buy today, you aren't paying the peak prices of 2000, but today's somewhat beaten down prices. Your basis is lower and future returns may be positive. It makes sense to have part of your portfolio in stocks. But don't think in terms of maximizing upside potential--that necessarily means maximizing exposure to downside risk. The past 21 years teach that risk of loss isn't a fictional bogeyman from fairy tales. You will lose money from time to time if you invest in stocks. But you may make some or all of it back, and perhaps enjoy net gains.

Put a good chunk of your portfolio in bonds and/or CDs. These investments add stability, and a bit of income. Reinvest the income (along with any dividends you get from your stocks) to get the benefit of compounding (for more on compounding, see http://blogger.uncleleosden.com/2009/09/if-you-love-compounding-compounding.html).

A portfolio invested 60% in stocks and 40% in bonds has historically performed pretty well in capturing most stock market gains while providing greater stability in value than stocks alone. As you get older, avoiding loss becomes more important than securing gains. So shifting as you age to a stocks/bonds and CDs ratio of 50-50, 40-60 and later 30-70 is prudent. None of this means you will necessarily make money. You may lose it. But you might lose more if you invest only in fixed income and money market instruments. Asset values, artificially inflated over the past 15 years by inordinate amounts of easy credit from central banks, have been deflating and may continue deflating for a long time. The only way to predictably increase your net worth is to save more. If you're nervous about the future, increase the amounts you're saving.

Where Is Financial Safety?

The debt ceiling deal was, more than anything else, an agreement to disagree. It had commensurate impact on the financial markets (i.e., nada). Because the deal resolved very little, Congress will continue to convulse over budget deficit issues. The stock markets, which are driven by politics as much as economics, will convulse synchronously.

Meanwhile, across the pond, the Euro bloc sovereign debt crisis is all the rage again, with Italy getting smacked around by the bond vigilantes. The EU doesn't seem to understand that its strategy of solving debt problems with bailouts that, net net, increase the amount of its debt will only lead to more instability. Because the EU has, in effect, collectively assumed liability for all of the debts of all Euro bloc members and all of their banking sectors, the aggregate amount of continental debt is what matters. The EU's relentless expansion of its liabilities, with each bailout diminishing its capacity for further bailouts, guarantees that the bond bandits will have a never-ending stream of dominoes to knock over. The average citizen, working on a brown bag lunch in a cubicle, will opine that reducing debt is the way to get out of financial trouble. But the hoi polloi, lacking sophistication, just don't understand that these things are complicated.

So, we can look forward to more stock market volatility. Where is there financial safety?

Swiss bonds have risen in popularity. But they don't have the liquidity of U.S. Treasuries. If you buy Swiss bonds, you had better like them because they won't be that easy to exit.

Japanese debt has also gotten attention, even though Japan's sovereign debt is about 200% of GDP, well above American levels. With almost all of Japan's debt held by its own citizens, it isn't likely to face serious capital flight. Indeed, the Japanese government seems to prefer a little capital flight. With the popularity of the yen pushing up its price, Japan's export-based economy is at risk. Even as we write, the Japanese government is intervening in the currency markets to push down the yen. If you buy yen-denominated debt, understand that you'll earn almost no yield and be at risk of currency losses from Japanese government yen smackdowns.

So what's left? Well, oddly, U.S. Treasuries. At least until the current debt ceiling is reached, probably in early 2013, U.S. government debt is safe. You may face some moderate inflation risk. But the long term picture for U.S. Treasuries--which isn't pretty--won't emerge for the next year or two. So, if you're worried about the stock market swan diving into a correction or bear market, Treasuries may be a safe place to hit the mattresses, at least for a while. Money market funds invested solely in U.S. Treasury securities are comparably safe, albeit exceptionally low-yielding.

FDIC insured bank accounts are also safe. The European debt crisis, in the worst case, could hit the U.S. banking sector pretty hard (because of interbank lending, derivatives exposures, and other bank interconnectedness). But the FDIC, with the backing of the U.S. Treasury, will protect insured deposits come hell, high water, plagues, swarms of locusts, loathsome diseases, or anything else. One hard lesson the government learned from the thousands of bank closures leading up to and during the Great Depression is that the loss of bank deposits wallops consumer confidence more than anything else. People don't look to their stockholdings or the equity in the house to cover next month's expenses. But if you take away their bank deposits, you create immediate household crises on a wholesale level. Make sure your bank deposits stay within insured levels (for more detail, see http://blogger.uncleleosden.com/2011/07/fdic-insurance-coverage.html).

We also discuss safe investments at http://blogger.uncleleosden.com/2010/07/safe-investments.html.

FDIC Insurance Coverage

Nothing's being resolved. The most recent flareup in the European sovereign debt crisis ended with Greece getting enough pocket change to tide it over for a couple of months, while the EU squabbles over the terms of a second Greek bailout. In other words, the can was kicked a short distance down the road, after Greece got a few hamburgers that it promised to pay for on Tuesday. But the prospects of a real solution are as bleak as ever.

The debt ceiling fight in Washington is getting louder and more strident. That could mean both sides are posturing for their supporters and preaching to their respective choirs for a while, before working out a last minute deal. Or else they might be heading for a showdown. The latter would be dumb, seeing as how it would flummox the financial markets. But then again we're talking about politicians, so dumb is s.o.p. The moody intransigence of today's politics makes it harder for politicians to compromise. The one hope we may have is the world's largest collection of hypocrites is in political Washington, and if driven by expediency, they'll readily go back on their words in order to save their glutei maximi.

Meanwhile, back at the ranch, the poor consumer has to figure out how to avoid having his or her own glutei maximi deep fried. The European sovereign debt crisis could trigger a financial crunch like 2008, except maybe worse. If the U.S. defaults on its debt, 2008 will seem like Party Central. When the going gets tough, the prudent make sure their bank accounts are FDIC insured. Here are the basics on coverage.

Each account "owner" gets $250,000 per bank. In other words, all of the owner's accounts are totaled, and up to $250,000 of deposits is protected. So if you have a checking account and a couple of CDs, their balances are aggregated and as much as $250,000 is covered.

Here's the fun part: you can be more than one type of owner, and each owner you become gets $250,000 of coverage. This isn't like the Internet where you might have multiple user names, and you don't need to have dissociative identity disorder. Just take on various different legal persona, and, presto, you get another $250K of coverage.

Start with you as an individual: $250,000 of coverage is provided for accounts in your name.

You as a joint account owner (such as with a spouse, parent or child): $250,000 of coverage for each joint account owner. So a joint account for a married couple gets $500,000 of total coverage.

You as the owner of an IRA: $250,000 of additional coverage for your IRA accounts.

You as the owner of a revocable trust account: another $250K of coverage per beneficiary.

You as the beneficiary of an irrevocable trust account: yet another $250K of coverage for all beneficial interests granted by the same person creating trusts (known to lawyers as the "settlor") at any one bank.

A corporation that you own: another $250K coverage, as long as you operate the corporation for an independent purpose (i.e., a purpose other than increasing your FDIC coverage).

Then, here's your ace in the hole: if the foregoing account types aren't enough to protect the enormity of your wealth, you can, until Dec. 31, 2012, get unlimited FDIC coverage for non-interest bearing transaction accounts. In other words, you can open a non-interest bearing checking account, and protect as many of your hard-earned shekels as you like until the end of 2012. If you hear some ringing that sounds like Hell's Bells, keep this in mind.

What are the chances that FDIC coverage will actually matter to you? So far, in 2011, 55 banks have been closed by the FDIC. In 2010, there were 157 bank closings. The number in 2009 was 140. Banks close when the financial system goes bonkers and the economy nosedives. If today's governmental debt crises keep metastasizing, more banks will fail, and holders of uninsured deposits will take losses. If your money is too concentrated for full coverage, spread it around.

In addition, if your money is an uninsured place, like a money market fund, you may want to move some or all of it into FDIC insured accounts. The European debt crisis has cast a cloud over money market funds holding commercial paper of European banks (which would be many of them; check to see if your fund holds it). The U.S. debt ceiling showdown could cause losses--probably minor, but you never know--for money market funds holding U.S. Treasury bills (many funds hold T-bills in varying amounts). FDIC protection for at least some of your cash may improve the quality of your sleep.

For more information on FDIC deposit insurance, go to http://www.fdic.gov/deposit/deposits/insured/index.html.