Larry Swedroe, author of The Only Guide to a Winning Investment Strategy You'll Ever Need.---an important book in my library, posted a MoneyWatch blog on November 19, 2010.[i]
Swedroe pointed out that our growing deficit is a piece of information and nothing more. Yes, the deficit begets much financial and political emotion, yet the large institutional investors that control market trading already have deficit information and emotion embedded into market prices. Any new information, such as the Treasury's adding of $600B more potential debt over the next several years, quickly adjusts market prices accordingly. In fact, if you kept up with the economists, they discussed the ongoing market adjustments leading up to the Treasury decision weeks in advance of the actual Treasury meeting. As we know, very little market volatility occurred after that meeting.
Swedroe adds that the US---with a Debt-to-GDP (Gross Domestic Product) Ratio of 90%---is but one of 28 countries in the Organization for Economic Cooperation and Development that have ratios between 23% to 199%. More than half are above 70%.
Interestingly, Swedroe pointed out that even though our debt level may impede our economic growth for years, normally this outcome increases stock returns.
Swedroe:
While deficits/debt negatively impact economic growth, there's actually a negative relationship between a country's growth rate and its stock returns. The explanation is similar to the reason value stocks produce higher returns than growth stocks despite producing much lower growth in earnings: Markets don't price growth, they price risk!
For developed countries from 1971 through 2008:
· High-growth countries (average real growth of about 1 percent) produced equity returns of 12.9 percent
· Low growth countries (average real growth of about -4 percent) produced stock returns of 13.5 percent.
The next time you hear politicians and pundits raise the roof as to how the deficit will destroy the stock market, please note that empirically there is no evidence to back up the claims; rather, the market historically performs better long-term in a lower growth environment!
And also remember, as was pointed out last newsletter, inflation worries are already priced into equities and bond prices.
Bottom line:
As I harp on repeatedly, have a long-term diversified portfolio strategy with a thorough risk evaluation. A competent financial planner will discuss risk at length with you. If you work with a stock broker, few of whom offer thorough financial planning, insurance company, bank, or invest on your own, it would be advisable to spend a couple thousand dollars on a thorough risk analysis and financial plan with a competent financial adviser. Certified Financial Planners can be found through Garrett Financial Network or the Financial Planning Association.
My strong sense is that poor risk strategy is what drives dentists to react emotionally to the market. I talk to countless dentists that have bailed out of the market at the bottom, only to enter again at the top. Yes, it's emotion that often drives poor decisions, yet a proper risk tolerance evaluation can nullify the emotions and provide solid long-term stability.
