Why the Stock Market is Safe Bet for Future
Given the current ups and downs in the market (mostly downs), can we still rely on the stock market as a hedge against the future? Heartland policy advisor, John Skorburg, looks at data from the great depression to answer this question.
His answer is, yes, for the long-term – a good mutual fund of stocks should outpace inflation. Here’s the rationale:
Whenever the stock market of an individual country moves up or down on a daily/weekly/monthly basis, various media reporters try to explain such movements either up or down with specific reasons such as: the market was up today because oil prices decreased or the market was down today causing gold prices to soar.
But what does data from the great depression tell us?
The survey of the literature linking inflation with stocks, begins essentially with Irving Fisher (1930), where Fisher reveals that inflation has a positive impact on the stock market.
Using the infamous Fisher Equation (Nominal Interest Rate = Real Interest Rate + Inflation Expectations), Fisher conjectures that stocks indeed are a hedge against inflation. Simply, the Fisher equation restated is: i = r + ð where i = the nominal interest rate, r = the real interest rate, and ð = the expected inflation rate.
Fisher used this equation to show that such an analysis applies to stock returns too. In short, Fisher states that the long-run relationship between inflation and the stock market is positive and that stocks are indeed a long-term hedge against inflation.
Follow up:
This initial research was published at a shaky time in American economic history. As such, Herald (in 1934) revisited Fisher and a very preliminary stock/inflation study by Edgar Smith (1923) noting that the stock market crash of 1929 had “shaken the common stock theory” as an inflation hedge, but it still stood on “a firm base” and had “not been destroyed.”
Future research in this area will help to determine if key commodity prices such as oil and gold have a specific relationship to stock returns and if stocks continue to be an inflation hedge in the long-run, even if short-term analysis continues to reveal that stock returns are only a partial inflation hedge. Still, after 75 years, the Fisher effect appears to hold under many specific circumstances.
In short, the stock market, in the long-term, still looks like a good bet!
Sign up for the OV Daily Newsletter
OV Social
Analysts love to tell you about all the money you would have by investing in the Dow in the 30s. I guess that's why they call them ANALysts.
Out of the 30 stocks that made up the Dow in the 1930s, only two have not gone bankrupt. While the dogs of the Dow are constantly replaced, which makes the charts look great, in the real world, when you own stock in a company that goes broke, you lose all of your money. You don't get to replace it with something better free of charge.
On the other hand, if you held gold in 1930 at $20 per ounce, it is now worth around $900. And, of course, if you held stock in 1930, you watched it lose 80% of its value in the following 2 years - that's on top of the initial crash of 1929.
There is only one way to make money in the stock market and that is to hold cash 90% of the time. Never, never, never buy and hold stocks. The longer you hold stocks, the more exposed you are to the market, and the more certain you will eventually be wiped out.
And, the more diversified your portfolio, the more closely your stocks will track broader indexes. In other words, you will never see big gains from hot companies or hot sectors. You will always end up applying those winnings to offset your loses on the dog stocks.
We are 9 months into a massive depression that will eventually make the 30s look like a Sunday picnic at Bill Gates' house. This is NOT a time to be holding stock, let alone buying stock. In a few years, there is likely going to be some very good bargains. Start making your list now of solid companies with low debt and high cash reserves. These days, those are generally going to be large cap tech companies, with very low dividend yields. Stay away from banks, insurance companies, home builders, retailers and anything else with high exposure to consumer spending and the economy. People without jobs don't buy cars, TVs, new homes, insurance or mutual funds.
When new claims for unemployment drop to half their current level, then it might be time to buy stock. That time is a LONG way off.