‘The Markets’ Are Amazing

September 8, 2020 Updated: September 8, 2020

Commentary

People who don’t know me often ask, “What do you think of the markets?” or “Should I invest?”

First of all: I think the markets are amazing at performing their primary function, which is helping all the world’s buyers and sellers come up with a price at which at least one seller is willing to sell and at least one buyer is willing to buy.

Of course, I know that’s not what they mean, but my silly answer usually gets the person asking the question to understand something a little bit about my belief about “the markets.”

And, similarly, the answer to the second question is always yes. No matter what. Everybody should save as early as possible and as much money as possible, as frequently as possible.

“The Market” is only one-quarter stocks—not counting real estate.

Obviously, what people really want to know is, “Should I invest my savings into the stock market?” Because of the way the media reports on markets, most people fail to understand that the U.S. stock market is only about a third as valuable as U.S. debt markets.

Debt markets basically trade the equivalent of loans made from one lender to a new lender without making the borrower repay the original loan.

This leads to my other tongue-in-cheek answer, which, of course, I always immediately explain because I wouldn’t anybody to walk away from the conversation and make a rash financial or investment decision.

An Anecdote to Remember

Here’s my favorite anecdote that I almost always provide after somebody asks me those two typical questions. If you are within five years of buying your first home, you should be “investing” most of your investment dollars in cash in a federally insured account, to accumulate enough money to make your down payment with very little risk of losing any of your hard-won savings. Perhaps the only exception would be to optimize how much you save in employer-sponsored savings plans to maximize after-tax total income.

Examples of such savings plans might include a health savings account or to invest the minimum amount to get the employer’s matching contribution into your 401(k) plan. Otherwise, pretty much all of your savings should be invested in that federally insured bank account or credit union account.

However, if you’re a 27-year-old lawyer who just won their first big law case, there is no romantic partner in the picture with whom you might want to buy a home, you think such a purchase is likely a few years away, and the prospect of future substantial earnings have a high probability, then perhaps a very large portion should be invested in investments such as the stock market. Invest it with a good suite of great fund managers and forget about it until you retire.

There are many measures of long-term historical returns for the stock market. My assumption for long-term stock market returns over very long periods of time is about 7 percent annually. Of course, valuations are currently high and there have been numerous “lost decades” of zero percent returns in the stock market; however, generally, a young professional with no need to save for a down payment can save early for retirement.

Tell Me the Future; I’ll Tell You How to Invest

My more sober, non-tongue-in-cheek answer is always the same: Tell me what news events are going to transpire and I’ll tell you what sorts of investments you should be in.

If the near future has geopolitical events (terrorism, war, disruptive trade disputes, etc.), then investments in very safe investments such as U.S. Treasury bonds will likely perform well. Long-dated U.S. Treasury bonds returned more than 30 percent during the fourth quarter of 2008, when the rest of the investment world was falling apart.

However, if strong economic expansion, high profits, a light regulatory regime, and an absence of geopolitics come to pass, then investments like stocks, high yield bonds, and companies purchased with leveraged buyouts will likely do well in that scenario.

2 Considerations Drive Securities Prices

I synthesize all investments into needing to know two things: 1) the future, and 2) what rate of return we all the world’s potential buyers—the real market—need to make this particular investment.

3 Major Future Events

By far, the three most important factors when assessing the future are 1) when will the pandemic end, 2) who will win the U.S. presidential and congressional elections in November, and 3) what will the Federal Reserve—the United States’ central bank—do going forward?

While I don’t have any particular insight regarding when the pandemic will end, paying attention to all the sources of potential insight is key for investors to consider. During the first week of September, markets reacted to news that a cruise line is making plans to launch a cruise from Italy. Some stocks that have done well during the pandemic suffered pretty sharp sell-offs.

The U.S. presidential and congressional elections take place on Nov. 3, and while many companies will do better or worse under a particular administration, still others won’t be affected very much by whoever is in the White House.

Investors are reminded to consider this important input into future scenarios of profits and investment returns.

Finally, on Sept. 16, the U.S. Federal Reserve will likely communicate regarding future inflation policy as well as its leaders’ beliefs about future interest rates, inflation, and growth rates. Traders will closely monitor how what Fed officials say in September differs from what they said on June 20 and recent data.

On June 20, Fed officials’ projections for this year were that gross domestic product (GDP) would shrink 6.5 percent, the year-end unemployment rate would be 9.3 percent, and inflation for the year will be 0.8 percent. For 2021, their projections in June were that the real GDP would grow 5.0 percent, the year-end unemployment rate would be 6.5 percent, and full-year inflation would be 1.6 percent.

June projections for 2022 were that the economy—GDP—is expected to grow 3.5 percent, unemployment would be 5.5 percent, and inflation would be 1.7 percent.

Readers are encouraged to read our online update after the Fed meeting on Sept. 16 for a full comparison.

Tim Shaler is a professional investor and economist based in Southern California. He is a regular columnist for The Epoch Times, where he exclusively provides some of his original economic analysis.

Views expressed in this article are the opinions of the author and do not necessarily reflect the views of The Epoch Times.