Invest for the Long Run
By Lawrence Kudlow
After weeks like this, when stocks collapsed across-the-board, it’s all too easy to forget in the emotion of
the moment that long-run stock market investing has proven to be the safest and surest path to wealth
creation.
For just a moment, put aside the near-term worries about the Fed’s liquidity crunch, declining profits,
rising recession probability, the poorly structured tax cut and so forth. Instead, consider this.
Over the past half-century big cap S&P 500 stocks have generated total returns of 13.4% annually
between 1947 and 1999, according to Ibbotson Associates. Small-cap stocks averaged 14.4% annually.
This period includes nine bear markets and nine recessions. Through it all, real gross domestic product
and corporate profits (national income basis) expanded by a handsome 3.5% yearly.
So if in fact we are experiencing the tenth bear market and the tenth recession, investors should not despair (overly). The fog
will lift and the sun will shine again. In America, it always does.
Why is this? Because this country has more economic freedom than virtually any other nation in the world. More freedom leads
to more entrepreneurship, growth and wealth. And there is no better barometer for the value of business and the outlook for
wealth than the stock market.
In particular, there are four major economic freedoms that sustain wealth and growth. Economist Arthur Laffer calls them the
four prosperity-inducers or, when freedoms diminish, they become prosperity-killers.
Freedoms from inflation, tax-rate spikes, trade protectionism and government over-regulation (including property rights
violations) are the key determinants of future growth and wealth.
In terms of prosperity-killers, the stagflationary 1970s were plagued by hyper-inflationary tax bracket creep and Nixonian wage
and price regulatory controls. The depressionary 1930s were wracked by monetary deflation, exorbitant tax-rates and tall trade
barriers.
These were the worst two stock market decades of the 20th century. From 1929 through 1939, large cap stocks declined
one-half of one percent per year. Between 1969 and 1979, big cap stocks returned 5.9% per year. However, inflation averaged
7.4% annually during the 1970s. So real returns were a negative 1.5% annually.
Today’s outlook is of course much better. Inflation is virtually zero, tax-rates are set to decline (though implementation may be
delayed), regulatory burdens are being rolled back (including barriers to energy production) and global free trade will be
expanded (especially hemispheric free trade with dollarization). What’s more, the end of the Cold War implies continued
downsizing of the size and scope of government.
Over the past twenty years, the fraction of GDP absorbed by the Federal government has fallen to 18% from 23*%. Continued
economic expansion combined with even modest budgetary restraint could bring that fraction down to 15% over the next
decade, according to the Congressional Budget Office. It’s a triumph of entrepreneurs over government planners. More
economic freedom. More wealth.
Ibbotson Associates’ 2000 Yearbook estimates that the Dow Jones Index will reach 100,000 by yearend 2025. This is based on
a 10% average compounded rate of capital appreciation, in line with actual historical data sets.
Back in 1974 Roger G. Ibbotson and Rex A.
Sinquefield forecasted that the Dow Jones would
reach 10,000 in November 1999. That level was
reached on March 29, 1999. It assumed
compounded returns of 13% annually. So
actually their next 25-year outlook of 10% growth
is rather conservative.
From my calculations, using the S&P 500’s
performance between 1982 and 2000, where the
annual rate of capital gains was 13.1%, it is
possible to predict a 4640 S&P level by 2010.
This is not based on short-term forecasts of the
fed funds rate, or second-half GDP growth, or the
structure and timing of the tax-cut bill. Nor does
it rely on specific GDP projections.
It merely assumes that the rise of economic
freedom over the past twenty years, including
the technology revolution with all its productivity
and growth-enhancing spillovers and
applications, will continue into the future.
Hence wealth creation, which has temporarily
stalled in the past twelve months, will resume at
something like the prior rate.
The S&P is currently around 1160. So the market looks undervalued. It’s a good time for long-run investing. Keep the faith,
investors. Faith is the spirit. |
