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Are The Days Of U.S. Stock Market Gains Over?

15 July 2008 One Comment

Today, I had an interesting conversation with one of my friends. He proposed several ideas to me that have me thinking. First, we discussed how if you would have invested in a well diversified portfolio of S&P 500 stocks a decade ago, you would be about even. Actually, down since inflation would be eating away your purchasing power. Sad? Well, my friend continued to say that this trend would continue for some time, and unless serious action taken to redirect our economy, the days of consistent gains in the U.S. market are over.

A House Of Cards

My friend believed that our economy for some time has been essentially a house of cards, built on phony money and over leveraging. Because our economy reached a certain size, it became difficult to achieve high growth levels needed to sustain high stock multiples. In order to continue such growth and such multiples, cheap money and high levels of debt were needed to fuel our economy.

The problem with such things fueling the economy is that eventually, the economy collapses. An economy fueled only by cheap money and debt creates bubbles and bubbles pop. This is the cycle we have been in for the last decade. Cheap money in the form of IPOs created the dot com boom. The tech bubble popped, rates were cut drastically to avoid a stagnant economy. This lead to the housing bubble. The increase in housing resulted in free money in the form of home equity loans. This free money resulting in high level of consumer spending. Now that money is dried up and people are losing their homes.

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Banks are failing and we are in a bear market. Is the economic domino scenario as described above so clear cut, so black and white? Probably not, but what comes next?

What’s Next?

Our economy will stabilize. Housing will stabilize, and banks will be re-capitalized (how many by our government?). The question is where will be the next area of growth fueled by easy money and debt? My friend believes that the growing economy of the U.S. ended 20 or so years ago and the growth since then has been a result of a financial system coupled with monetary policy contributing to high growth. With a financial system in shambles and a monetary policy not working (low rates are not saving the economy and are leading to higher inflation), what is the next quick fix? How do we fix our struggling economy?

Eventually, we can’t cut rates anymore. Eventually, no more debt can be issued. What then? Especially, with record energy and commodity prices in the picture, what then?

Unfortunately, it seems the only way through this economic environment is to deal with the pain. There doesn’t seem to be a way to avoid the extension of the current environment. Energy prices will remain high, home values will decline further, and jobs will contract. Retirement plans will shrink, 401(k) accounts will decrease, and more Americans will struggle to remain financially healthy. It seems that the way out of this scenario is a long, sustained period of minimal to slow growth (similar to Japan of the last 15 years possibly?).

Our Leaders Won’t Fix The Economy

I realize that this is a very pessimistic post. This scenario probably won’t play out exactly as I describe, but what reason do I have not to believe it won’t? My politicians are short sighted and refuse to address long term economic fundamentals in our country. George W Bush, Barack Obama, John McCain, and others are too worried about the economy in 2008 rather than the sustained economic future of America. These politicians would rather issue stimulus checks to ease short term pain than to put our future on a strong footing. More spending, more stimulus checks and more regulation are what our government wants instead of doing the things that will ensure a strong economy for our grandchildren. America needs a strong currency, a reduced debt and a small government.

Add to the fact that the U.S. government will soon own the $5 trillion in mortgage debt from the companies Fannie Mae and Freddie Mac and we have more national debt. Instead of debating the form of a short term stimulus, how about we worry about creating markets that are not so intertwined that we can let irresponsible banks actually fail instead of having to assume trillions in additional debt?

I could go on for hours about what pisses me off in our government, but let’s stear away from this and focus on how to make money if the above scenario plays out. How can we make money if the U.S. stock market gains are over? Yes, I know advisers will tell you that you are guaranteed 10% returns annually over the long term in stocks. I’m not so sure anymore.

You Can Still Make Money

I believe a diversified portfolio in U.S. stocks will go nowhere. In fact, you will lose money most likely. If growth is done in our economy for some time, we will have multiple contraction. Stock prices will decrease because they cannot command a high multiple to justify weak growth.

What is the answer? Picking winning stocks or finding a trading strategy to exploit short term trends. This blog is dedicated to helping you find both. I have had a great year so far with Chesapeake Energy (CHK) and Apple (AAPL). I also like Philip Morris International (PM). PM has been up nicely in the last month as the entire market has been tanking. Oh yeah, also, Apple just sold a million iPhones in the first weekend of sale. Talk about bucking an economic trend!

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One Comment »

  • ConnieB said:

    I would possibly pinpoint commodities themselves as the next bubble.

    Your friend is very right that we are building a very unsteady house of cards. One of the MSN Money writers Bill Fleckenstein (Quite sure I’m spelling that wrong…)has just put out a book called “Greenspan’s Bubbles.” Even though he demonizes Greenspan in it, a lot of the information in the book is very sound.

    I;ve been hearing a lot of theories in the PF circle lately that diversification is not the way to go.

    Personally, I believe it is the way to go, but that most people do not take enough risk. A good mix of the two is probably the best bet. I;d hate to think I had a completely unbalanced portfolio just to try to earn more quicker. I plan to retire early and the secure half of my portfolio is what holds up my own house of cards.

    Thanks for the article. Gave me much to think about!