A dirty little secret about the stock market

Wow. Now here's something that will blow your mind if you believe stocks are the best place to invest your money:

A study of 160 investment advisors over the last 30 years shows the single top performing advisor of the bunch holds only about 20% in stocks!

The last 30 years, it should be pointed out, had possibly the largest bull market run for the stock market in history. Yet Charles Allmon was never more than 50% in stocks; most of the time he had less than 25% of his portfolio in stock. And only a few stable, high-dividend stocks at that. Turns out that over the last 30 years, a time frame in which stocks have done exceptionally well by historical standards, you could have done just about as well parking your money in safe money market accounts.

Of course, most financial advisors will tell you stocks are the best investment in the long run. I'm sure the fact that stocks are most profitable for these financial advisors has a little something to do with that. Of course, it should be noted that yes, historically stocks have done quite well relative to other investments. But, as Paul Krugman noted in an essay in The Economists Voice, that probably just means that historically stocks have been under-priced. By historic standards, stocks are priced very high today, indicating those rich returns of the past may not be the reality anytime in the near future. Look at it this way, the market has a choice of different investment vehicles. If one vehicle consistently outperforms the others, the market will recognize that and bid up the price until the performance matches the price. If history is any indication, investors will bid up the price beyond the point it's a good deal, thus rendering the asset to be an inferior choice even though historically it was a better choice.

Given the phenomenal performance of stocks in the 80's and 90's, and the subsequent abysmal performance, I think we're just seeing the reversion to the mean for stocks. This process will probably play out for quite some time before stocks become a superior asset class again.

What if there's no fix for high unemployment?

The above Fortune article asks a brave question. The central idea of the article is asking the question of whether we may be reaching a point where technological progress is eliminating jobs faster than new ideas, products, and industries can replace them, leading to permanently higher unemployment. Anybody who dares assert that technology might just possibly in the long run have any sort of negative impact on employment is automatically an imbecile and/or heretic in many economic circles.

Of course, to the general public, the idea that technology which replaces workers will cause unemployment seems obvious. The reality is much more tricky. Because it seems apparent, but time and time again has wound up being false and there are models explaining why it's false, many people with the most fundamental economic education assume anybody who would make this observation, or hint that there might be something to this observation, must be some sort of ignorant rube. Over the last two centuries, technological innovation has been accelerating relentlessly, while populations have been growing exponentially, yet in the developed world we have generally been able to find employment for nearly everybody, with temporary exceptions during downturns in the economic cycle. When technology renders one type of job obsolete, another way has always been found to employ the labor of those displaced. This has been true for centuries.

For centuries, it was also true that US housing prices did not dramatically drop across the board. So it turns out centuries of observation is not adequate to formulate an unbreakable economic law. And given our historically high unemployment levels, I think it's fair to question this observation. Perhaps the observation will continue to hold and in a few years everything will be back to normal.

But one has to wonder just how many more productive uses of human labor we can come up with. We produce more food than the world can eat--though people go hungry because they don't have jobs to earn income to buy food. We have more houses in the developed world than we have families to live in them--though people go homeless because they don't have enough income. There are more cars in the developed world than people to drive them--though, again, not everybody can afford one. We have access to more entertainment and communications technologies than anybody could ever use. It is hard to think of anything for which there is a shortage in the developed world--with the exception of positional goods. Positional goods are things like "better" schools or "better" neighborhoods...items that only have value because they are perceived as more desirable than alternatives, even though the alternatives are perfectly adequate by objective standards.

In an absolute sense, there's very little that can actually be produced to add to the economy in the developed world. The best way to "grow" the economy is through the inflation of prices for positional goods. Higher education (which is better than secondary education) has seen skyrocketing prices even though there's little evidence today's graduates are much smarter than a few decades ago, health care costs (particularly at institutions deemed better than average) have skyrocketed while life expectancies (at least in the US) have barely budged, real estate costs have skyrocketed as people compete for the limited homes available in "above average" locations, spending on financial advise and products have skyrocketed as people chase better than average returns--and most investments have performed at rates near historical lows in the US.

In short, we're running out of actual wants and needs to meet by putting people to work. We've produced nearly everything anybody can possibly use, and we're simply competing to see who will get the "better" goods out of what is produced. At the same time, companies continue to find more efficient ways to produce these goods, which means less labor is needed to produce them.

It seems like at some point, we'll hit a wall where we realize there just aren't enough productive things for people to do to maintain anything close to full employment. Of course, that's been said before, and it's been wrong over and over again. But then, people who were worried about home prices dropping were wrong over and over again too...

Just the Facts

The above chart shows US GDP over a time period of well over a century on a log scale. That dramatic upturn on the far right represents well over a decade. I've removed the years from the bottom for purposes of posing a question. What year do you think this graph ends?

First, a little background. This chart comes from measuringworth.com, one of the greatest collections of economic data on the internet. Not only is there a ton of information available, but it's very easy to request exactly what you need and get it in either a table format or a convenient chart. These charts are done in log form because that's the only way to get a sense of the growth rate over time. If you don't do a log chart, nearly every economic chart looks like a hockey stick. That's because the same growth rate over time (say, 3%) results in exponential growth. 3% growth when GDP is $1 billion produces way less growth than 3% growth when GDP is $1 trillion. Also, this chart uses "real GDP", which attempts to correct for the effects of inflation. The result, over long periods of time in the US, is what appears to be remarkably smooth growth. Now...back to the quiz...

If you're a fan of Reagan, you probably assume that dramatic upturn is thanks to Reagan's strong growth policies. You've got the dramatic downturn just before that, which must represent the stagnant 70's. And you've got the beginning of a collapse at the end. So naturally, this graph must end in the present day or some very recent year.

Yes, that would make sense if you live in the fact-free world of political ideology.

OK, so now here's the full chart, with years, for the years 1790-2005:

So when did that remarkable, unmatched period of economic growth occur in the US? That's right, it was the FDR years. The beginning of the remarkable upturn occurs precisely in 1933, the year FDR took office. The end occurs in 1945, as WWII begins winding down. During that decade-plus of near-socialism--with sky-high taxes, incredible government interference in the economy, and out-of-control government spending--the US experienced an average GDP growth of roughly 10%.

Yet if you listen to so many pundits and politicians today, they'll tell you low taxes are the key to prosperity, FDR's big government economic policies failed, and many other whoppers that simply don't stand up to scrutiny. The "Reagan boom" of the '80's doesn't even show up in the chart. The "big government is over" boom of Clinton...you can't even see it. The only decade-plus period of economic growth in American history that significantly stands out from any other period is the New Deal era.

One other interesting item...there's only one large country in the new millenium that has managed to achieve that magic combination of average annual growth of 10% or more over a period of a decade or more. That country, of course, is China. And I don't think anybody would dispute that China's economy runs with a heavy dose of government intervention.

Central planning without markets is a proven failure. But free markets without central planning have also proven to be a colossal failure over and over again. A healthy economy needs a strong dose of both.