And nobody came. I'm beginning to wonder if the flash crash, allegations (strong) of corruption, and unsuspected linkages to other economic events aren't taking an enormous toll on stock market investor enthusiasm. Part of the reason could be new questions about the presumption of a risk premium: riskier assets will generate higher returns. Stocks are riskier than bonds, ergo stocks will pay off better in the long haul.
EQUITIES just aren't what they used to be. It was once gospel that equities out-perform low-risk bonds. But if you invested in the stockmarket around 1999 the balance of your portfolio probably suggests otherwise. During the post-war era equity returns have been positive. Enough so that the equity-risk premium, the return equities generate in excess of the risk-free rate (which is normally short-term Treasuries), is often assumed to be between 5% to 8%. In my experience risk managers go silent when asked where exactly this number comes from. Usually it is based on some historical data with a dose of "sensible judgment". Clearly, the size of the expected equity premium depends on the timeframe you use and the manager.
I recently spoke to an auditor who described the difficulty involved in calculating today's equity premium. If you use recent history in your estimation, you may end up with a zero or negative equity premium. No one wants to use this in their forecasts; otherwise projections look pretty dismal. If you're selling a financial product or strategy that involves equity investment, a zero equity premium will not entice investors. [More]
In fact, discovering that most stock markets are largely made up of computers tossing equities back and forth very quickly doesn't make them particularly attractive to me, for one. And I know relatively little about portfolio theory. Felix Salmon knows lots, and he is offering a sobering prediction for equities.
This is the heart of my case against investing in stocks. For one thing, you have no good reason to expect an equity premium going forwards, and if there isn’t an equity premium, then your allocation to stocks should be tiny: you’re not being compensated for the extra risk you’re taking. On top of that is the question of volatility, which is not exactly the same as risk, but which again should be compensated for with higher returns, and isn’t.The idea of hitting the trifecta seemed vaguely familiar. Who else in the US has seen their income rise steadily (occasionally spectacularly), has seen their major real estate investment soar, and also their retirement income projections rise smartly?
My feeling is that people like to invest in stocks because they like knowing that there’s a chance that the stock market will solve all their financial problems when it rises. Think of it as a three-pronged strategy: buy a house, invest in stocks, and work hard. Any one of these three things can pay off with lots of money at retirement, in the way that investing in TIPS won’t.
What’s more, an entire generation of Americans started working and saving and buying a house in the early 1970s — and millions of them hit the trifecta, becoming successful in their careers even as their stocks rose and the value of their real-estate soared. I doubt that particular combination is going to happen again in the U.S., but the experience of that generation is so powerful as to give a lot of people a lot of hope. Even if that hope isn’t particularly rational. [More]
No, no - don't tell me - I know this one.
Given the widespread - and still growing - disillusionment with investor choices, maybe the love affair with farm investment is just beginning. If so, our tiny asset base could trigger even more outlandish results than we have seen.
Do the income fundamentals justify current land prices? Not even when you squeeze all the cash rent you can, IMHO. Yet the march upward continues.