Courtesy of Doug Short.
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What’s “normal” for financial markets and investing?
A brief stroll through the last 100 years
In the 20th century, we all became accustomed to a “normal” that meant the following:
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- Free market capitalism
- Economic growth
- Rising wages
- Rising living standards
- Improving life expectancies
- “8-10% average annual returns” from the stock market (as so many financial advisors are fond of saying to this day).
It was a century in which American ingenuity, productivity, and industry dominated and led the world – especially after World War II.
Even so, we all know the 20th century version of “normal” wasn’t always a picnic. “Normal” also included a continuous parade of seemingly impossible challenges. In the U.S., we endured – and eventually overcame – the Great Depression. We miraculously prevailed in 2 horrendous, high-stakes World Wars, after tremendous cost and sacrifice. Later, we fought in Korea and Vietnam, and survived a frightening Cold War with the communist Soviet Union – which also ended better than anyone ever expected after more than 4 decades living in fear of nuclear attack. We persisted through assassinations, impeachments, riots, oil embargos, runaway inflation, hostages, conflicts in the Middle East, and many other real human tragedies that were more than just awful news headlines.
Incredibly, the stock market really did return about 10% annually (or about 6.5% above inflation) throughout that 100-year period. To be sure, though, the stock market did NOT always deliver those “8-10%” returns for every generation – even in the unparalleled 20th century! Those who endured the Great Depression never tasted wealth created by investing, outside of an elite few. Another major season of misery was 1966-1982, when the Dow Jones Industrial Average took nearly 17 years to go from 995 to 1000 (that’s right; the Dow finally surpassed the 1000 level in 1982, after many ups & downs). Over that period, stocks averaged +5.9% per year, including dividends. That’s not too bad, right? Until you consider that inflation averaged +7.0% per year! Investors made money on paper – but after paying investment commissions and taxes, they lost significant ground to inflation every year… for 17 years! In fact, 44 years later (in 2010), a person who started investing in February 1966 still would’ve been better off with low-risk bonds than with stocks! That’s how bad the 1960s and 1970s were, and it shows the importance of not “buying high”!
Despite all the tough times, though, “normal” in the 20th century meant America always triumphed. Billionaire investor Warren Buffett (and others) continued to “bet on America,” and continued to win. The economy always achieved new highs and markets did, too.
In the end, the 1980s and ‘90s exuded a widespread feeling that Americans needn’t argue about the minutia of “dividing” its economic “pie,” but could instead trust that pie to grow larger and larger for everyone. I attended high school and college during those years, and developed a real optimism about the future – both for myself and for America.
Then in March 2000, an historic stock market bubble began to burst, wiping out about 50% of the markets’ value in a 30-month slide. The 9/11/2001 terrorist attacks struck America right in the middle of that dark chapter. All told, most investors from Wall Street to Main Street lost more than half their nest eggs. Retirement accounts were decimated. I started working as a financial advisor in July 2002, and my mentor’s client’s accounts – and their psyche – were pretty ugly. But… no problem, right? Surely this “crash” was just another speed bump that Americans would overcome. We (or our parents and grandparents) had been through worse before. And so we all looked forward. Like our forebears, we really had no other choice. And for a while, things seemed to work out.
Stocks finally did hit rock bottom in October 2002, and a 5-year recovery began. And then lightning struck again. By late 2007, more bubbles had begun to burst. This time housing, the stock market, and credit had all become way too silly. The Global Financial Panic of 2008 saw unsuspecting investors in both stocks and real estate lose half their nest eggs (or more) … again. Real estate’s crash hurt millions of average folks, and the stock market lost more than 50% of its value. For months, the whole global financial system seemed on the verge of crumbling. Governments and central banks made new headlines – with new acronyms and programs – nearly every day, in their efforts to take control.
The world didn’t end in 2008. We’ve seen a recovery; but the last 5 years have delivered the WEAKEST recovery following a major downturn in U.S. history, in terms of economic growth and employment. Somehow, though, that same “weak” 5-year recovery has also seen one of the FASTEST stock market rallies ever. Dr. Gary Shilling, a top economist and best-selling finance author, has called the disparity between our slow-growth economy and our surging stock market a “Grand Disconnect” that’s “unsustainable.” This “disconnect” has turned many of us from “optimists” into “realists” – at least when it comes to evaluating future prospects for investing in stocks. (Actually, for me, I’ve simply changed the focus of my optimism. I remain optimistic about the power of any true free-market system, but for me, my optimism no longer translates into a blind faith in relying upon the U.S. stock market to perform as it did in the 1980s and 1990s – both because of fundamental changes in our “free market system” and because I see the stock market as being already too high-priced to make it an attractive buy-and-hold proposition. Instead, my “new optimism” is that people like you & me can still succeed anyway, by taking more control over our own futures, using stocks only opportunistically as a small piece of a portfolio that’s built on more solid, foundational assets designed to deliver consistently compounding returns… rather than pretending volatile stocks are themselves a suitable foundation for a portfolio).
A “new” normal?
The events and wild swings of the last 15 years have led many to ask, “When will markets return to ‘normal’?” One of the most recognizable, respected economic experts, the former manager of Harvard’s endowment fund, Mohamed El-Erian, famously declared markets to be entering a “new normal” in May 2009 (just as the global financial meltdown was ending). El-Erian defined the “new normal” to be an extended period in which the economy and employment would experience structurally and persistently slower growth than in the past.
El-Erian’s “new normal” phrase seems to imply he believes we may never return to the “old normal” (anytime soon).
Do you believe that could be true?! The question is one of the most critical issues facing any investor today.
Many believe the “old normal” of the 20th century is a thing of the past, and that we truly are bound to be stuck in a slower-growth mode, possibly for decades. El-Erian (who has been basically correct so far regarding economic growth and employment) continues to say we’re in for “more of the same,” according to a March 2014 interview with Business Insider. Yet one must admit that all throughout the 20th century, the U.S. economy has always had doubters and naysayers. At least then, our free-market system always prevailed. Is the resiliency of the stock market signaling the U.S. economy will rise again? Or is this time different?
Are we in a “new,” slower-growth “normal”?
Here are the numbers so far:
After WWII, the U.S. economy grew at a real annual rate of about +3.65% per year, from 1950-1999. Growth tanked from 2000-2002 (while the stock market bubble was bursting), then resumed a +3.15% real annualized rate from 2003-2006. The Global Financial Crisis really began in 2007, and El-Erian proclaimed a “new normal” of slower growth in May 2009 (about 2 months after stocks touched bottom). Since then, economic growth has been a measly +2.20% annualized, from July 2009 – June 2014. All data from the Bureau of Economic Analysis.
In an economy as big as ours, there’s a big difference between, say, +3.5% real growth per year and 2.2%. It’s a 38% drop-off, to be precise. Where has nearly 40% of our growth gone?! When will our “recovery” pick up some steam? Or are we really in a “new normal” to which we all must simply adapt?
Is this a “new normal”?
The chart above shows that we’ve been in a slower-growth period, for 5 years anyway (even after the crash ended) – just as El-Erian predicted.
Maybe this is just a blip. The U.S. economy has always had (and will always have) its doubters, and yet it’s always gone on to set new records.
Still, 5 years is 5 years, and something is (or some things are) contributing to the slow growth that’s occurring. As investors, we need to understand what’s happening and why.
Let’s look at what conditions exist that might be contributing to this current slow-down. Let’s also consider whether some of these conditions might be unique to this period in history, and whether they’re likely to improve. Here are a few:
- A hyperactive Federal Reserve (Fed). If there’s one thing that’s unprecedented – even experimental – it’s the Fed’s manipulative monetary policies since 2008. Janet Yellen seems an unlikely character to reverse the massive money-printing course set by Bernanke, et. al. Once a central bank or (“quasi-”) government agency gets bigger and/or acquires some new power, getting that entity to shrink back to its former, less influential days is pretty rare, to say the least. This case is no different. Make no mistake: the Fed is not yet “shrinking”; rather, it’s simply slowing the rate at which it’s growing. Many people seem to forget that fact in the midst of so-called Fed “tapering.”
The Fed may seem to have markets pretty much “under control” for now, but I seriously doubt they can manage things so smoothly forever without things unraveling. By the way, having a central body in “control” is not exactly one of the free-market principles that led to such prosperity in the 20th century.
- Stagnant personal incomes. Household income today is about -6% lower than in 2000 (on average, after adjusting for inflation based on CPI). Declining real income for a few years is not uncommon, especially during recessions; but what’s unusual is the sheer length of time this trend has persisted (nearly 15 years now). The worst of the decline occurred from 2008-2011. At one point in 2011, incomes were about -9.6% below their 2000 levels. The modest uptick since 2011 hopefully implies some hope for real improvement. So far, though, the data on stagnant wages seem to ring true with reality “on the ground” for many people, unfortunately, and also with the prevailing theme of “weak recovery.” The problem, of course, is that when people make less money, economic growth is restrained. And the question is, how long will this downward pressure on take-home pay continue? Unemployment and income has been the major topic at this week’s meeting of central bankers in Jackson Hole, Wyoming. Maybe they can solve it (sarcasm).
- Rising taxes and government regulations. One of my favorite economists, John Mauldin, recently wrote this (emphasis added):
| “(I’m beginning) to ponder whether our government has become so complex that it has begun to stifle the flow of information. Dodd-Frank. The Affordable Care Act. Energy policy. The list goes on and on. Are we taking all the profit out of the system in order to comply with complex rules and regulations? Not for large companies, necessarily, but for small ones? When we are losing companies faster than new ones are being created, that should be a huge warning flag that something is wrong in the system.” (Mauldin Economics, Outside the Box, 8/6/2014) |
Mauldin then shows a 2011 chart from the Brookings Institute that shows new businesses startups (read: new employers) entering the marketplace at only about two-thirds the rate they did in the mid-1980s. That “firm entry rate” has actually been in steady decline since at least 1978 (according to the chart), plunging most severely from 2007-2009 or so (during the crash and recession). I agree with Mauldin’s musings quoted above. My own humble opinion, based on my sense for what’s “happening out there,” is that much of the reason for the decline in new businesses really is that government is making life harder and harder for those who might otherwise become entrepreneurs. Unfortunately, the trend of higher taxes and regulations doesn’t currently look like it’s showing any signs of reversing. In fact, for at least the next 2 years of Obama’s presidency, the burden may become even worse. Perhaps (hopefully!) voters will have something to say about that in this November’s mid-term elections.
- An aging labor force. In the U.S. and many other developed nations, the proportion of potential workers actually participating in the labor force is in decline. In fact, this is another one that goes all the way back 15 years. In 2000, the “labor force participation rate” was over 67%. The rate has continually fallen since then, from about 66% in 2008 down to about 63% today. This represents thousands of lost workers in the economy. Many have lost interest in working due to few perceived opportunities, but most simply represent the 1st wave of Baby Boomers to reach retirement age. Of course, we already know the Baby Boomer retirement trend will be with us for another 15 years. What’s the likely impact of an aging labor force in terms of economic growth? Dr. David Kelly, Chief Global Strategist for J.P. Morgan Funds, recently wrote this:
| “The U.S. economy is likely to grow at a rate closer to 2% instead of its long-term average of 3%, in part because of demographic trends that are shrinking the available supply of workers.” (J.P Morgan Funds, WorldView 3Q 2014, released 8/20/2014) |
- Debt. Like the aforementioned Fed experiment, this generation’s government and private debt levels – not to mention $118 Trillion in unfunded entitlement liabilities (over $1 Million per taxpayer) – are unprecedented in U.S. history. Somehow, this hasn’t yet totally imploded, although overleveraging definitely played a major role in the collapse of 2007-2009. The debt bubble did burst, but is now in the process of re-inflating. We haven’t corrected the problem.
- A growing societal acceptance of dependency on government. Personal responsibility is on the decline. Sad, but true. The sheer number of people seeking government assistance is staggering – including record numbers of people on food stamps and disability benefits (of all things). Obviously, this condition doesn’t describe everyone in America, but a large and growing contingent is willing to allow government to take care of them – which can’t be interpreted as a sign of a healthy capitalist society. More on this below.
Of course, those are just a few of the possible explanations for the weak recovery. Time will tell whether this “extended period of slower growth” is a “new normal,” or whether our economy is on the cusp of a new growth phase even now. As investors, we’d be wise to remember humility. None of us know how the next 5, 10, 15, or 20 years will turn out. Even if we could perform the most elegant, complex analysis & forecasting the world has ever seen, we still wouldn’t know what unforeseen events and variables will occur – and it’s usually those unexpected “black swans” that make all the difference. As investors, we simply need to be attentive to our portfolios as events unfold.
Thoughts to chew on until next week
This is already one of my longest blog posts ever. I’m going to stop typing now, and give you time to mull all this over. I have a “Part 2” almost completely written, which I’ll finalize and post within the next week.
“Part 2” (which is about as lengthy as “Part 1”) will take the risk of looking ahead. I’ll also unveil a little “twist” in “old normal” vs. “new normal” debate, which I picked up in my research over the past month or so. You’ll want to digest it. I think the “twist” could be the most compelling forecast of what’s coming next. Oh, and “Part 2” will also reveal why I’ve titled this article “The Eye of the Storm.” Hint, hint.
Before I sign off for today, I’ll give you a little more to chew on regarding the “reasons” for slower economic growth. Try to enjoy. I know this is not the most uplifting topic.
Bill O’Reilly said in an epic memo on his show 2 weeks ago:
“I’ve been in media about 40 years now, and I’ve never seen America weaker than it is today.”
Powerful statement. I know he intentionally made it so.
In the memo, O’Reilly listed several reasons to back up his point, many of which I fear to be true. He covered America’s declining power overseas, the national debt, chronically declining real wages over the last 15 years, societal decline, toxic politics, an apathetic and ill-informed public, and on and on. Take a moment to ponder that list.
Also within the video, O’Reilly comments about government policies creating (not helping) income inequality in our country. Interesting. O’Reilly specifies that policies have curtailed job development and fostered a greater sense of dependency upon government, both of which fail to help the poor via a “hand up” instead of a “hand-out.” Hard to argue that point.
I encourage you to watch the O’Reilly segment (here). It’s not all new information, but it’s definitely worth 7 minutes of your time. “Take Time” for it.
Until next time, then, consider whether you believe this “new normal” idea is really true. Is America in for a continuation of the last 5 years’ slow growth? You wouldn’t know it from our stock market! Many smart people have questioned America’s resilience before, only to be proven wrong. Is this time different?
© Adam Feik
Take Time for This
This article is for informational purposes and does not constitute individualized investment, financial, tax, or legal advice. See additional disclosures here.
