A steady drumbeat of articles proclaiming the death of the equity cult has cited many reasons, including loss of faith in equities due to various reasons, new alternative investments, baby boomers retiring and shifting from stocks to bonds, and projected anemic growth in the US vs other countries. Let’s take a look at some of these reasons with an analytical eye.
Straight off the bat, we can dispense with all the psychology-based reasons. Yes, the public is currently burnt by a decade of equity underperformance, scared by the flash crash in May, disgusted with bankers on Wall Street, and convinced that the investment game is rigged against them. But no, this will not be a permanent situation. Psychology changes, and fads and fashions come and go like clockwork.
Then, there is the proliferation of ways to invest in alternative asset classes, and the fact that an aging population should theoretically hold more bonds and less stocks. This explanation has a large kernel of truth. There are now more ways than ever for the retail investors to dabble in commodities, forex, and options. But these alternative asset classes have historically gone nowhere or declined over long periods of time, and for a good fundamental reason, because they are not productive assets with a cash flow. That leaves bonds, the traditional safer alternative to stocks, with positive cash flow. Bonds are less volatile and have a more certain cash flow than stocks, and should indeed make up a large portion of a retiree’s portfolio, especially one who relies on cash flow from his portfolio for living expenses. However, current bond yields are at historic lows, which is another way of saying that bonds are over-valued. Surviving on 1-2% bond yields is going to be difficult for many retirees, especially those who have under-saved for decades. In comparison, stocks are cheap, with many solid large cap companies selling at high earnings yields. A stock portfolio can be managed to generate cash flow through dividends and liquidating stocks which have appreciated, although this is admittedly more uncertain and less straightforward then simply holding a bond portfolio with a defined cash flow. Still, many retirees may have little choice as they are unable to survive on the low bond yields.
Lastly, there is the question of future US growth and its impact on domestic stocks. Certainly, the US economy is mature, and greater economic growth can be expected in overseas emerging economies. There is a strong case to be made for diversification into foreign stocks. However, with looser regulations and much less available information about stocks, it is not clear that the value that can be expected from stronger economic growth will flow into the pockets of minority shareholders (as opposed to, say, majority owners and management), nor will it be easy to find enough accurate information to judge the companies. I have dabbled in foreign stocks, and in practice, I found that the language barrier is formidable, and the only foreign stocks which have trusted annual reports written in English are in mature European economies with limited growth prospects anyway. In the end, I think that for the average retail investor, the US stock market presents many investment opportunities and a portfolio of twenty carefully chosen stocks will give the greatest return for the lowest risk over the long term.
