Note from our CIO: Apocalypse Du Jour

At a recent lecture I gave in my Science and Art of Investing course at UCLA, my students came up with three significant financial calamities that they feared could derail the world’s investment markets. These included the prospect of US debt burdens rising to unrecoverable levels and European economies and the euro falling apart. This quarter’s CIO message offers compelling counter-arguments to each of these prognoses.

Calamity: U.S. debt is rising to frightening levels.

Counter Arguments:

1. Business spending on equipment and computers – one the most important indicators of economic growth – is at an all time high. It was about $500 billion in 1995 and it is over $1.2 trillion today (even after adjusting for inflation). Growth of the real economy is the sustainable path to eventually containing the debt burden.
2. America is gearing up to be a manufacturing powerhouse again, fueled (literally) by a hundred years of untapped natural gas reserves and by game-changing technologies such as 3D printing (which makes physical objects from a digital file). Chinese labor costs are rising at 20% per year while the costs of robotics are falling 30% per year.

Calamity: European economies and the euro are falling apart.

Counter Arguments:

1. While governments are in trouble, businesses are thriving. The reality is that in the first half of this year, corporate profits increased to 8% of their share prices, while the yield on bonds (the natural “safe harbor” when economies appear to be falling apart) is about 1.75%. This is the single biggest spread between the yield on company ownership and bonds since 1956, and hence stocks have never looked cheaper on a relative basis.
2. Every day, many thousands of people are being vaulted out of poverty and into the middle class in Brazil, India, China, Turkey Indonesia and the Philippines. This is a mega-macro trend that will reshape the global economy over our investment lifetimes.

Calamity: There is no end to this housing market slump.

Counter Argument: Affordability of home ownership has skyrocketed, especially with the historic drop in mortgage rates. It is now more affordable to buy, versus rent, in over 50% of metropolitan cities. A recent Wall Street Journal article highlighted the return of bidding wars on houses in many communities. At the same time, Bloomberg reported that April was a five-year low in foreclosures and we had a 10% rise in housing prices over the previous 12 months.

The aim of this exercise was, in no way, to dismiss or solve the great economic challenges faced today by the U.S., Europe and the rest of the world because those challenges are real, and their consequences are dire for millions of people. The aim was: 1. To remind us that there is just as much about which to be hopeful – if not more — as there is to be fearful; a difficult perspective to maintain in our world of one-sided, catastrophist journalism. 2. To point out that many of the risks we face are of the short-term, temporary nature, while the counter forces tend to be of the long-term, permanent nature; again, a perspective that is easy to lose sight of.

We, as humans, are not hardwired to be successful investors. Our emotions tell us to sell stocks when things look bad – which is exactly when we should be accumulating at cheap prices – and to get back in when things look better – which invariably leads to buying at new market highs and missing the returns. Your financial advisor at Abacus is committed to your successful investment experience by ensuring you make great financial decisions based on sound, unbiased evidence and research.