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Three Reasons Why Stocks Might Struggle

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May 19, 2009 – Comments (0)

Just a few random thoughts this morning about the stock market's possible headwinds. Here are three reasons why stocks might struggle.

1. Higher interest rates

Back in 1999, Warren Buffett gave a series of speeches about the future of the stock market. He pointed out that on Dec. 31, 1964, the Dow was at 874. Seventeen years later, on Dec. 31, 1981, the Dow was at 875. Buffett said, "Now I'm known as a long-term investor and a patient guy, but that is not my idea of a big move."

One of the factros the led to sluggish stocks prices was rising interest rates. "These act on financial valuations the way gravity acts on matter. The higher the rate, the greater the downward pull." 

From 1964 to 1981, the rates on long-term government bonds increased from 4% to 15%, and stocks were stagnant. Then the trend reversed, contributing to the greatest bull market in history. 

Today, the rate on the long-term government bond today is once again 4%. Given all Uncle Sam's borrowing, which direction do you think rates are headed? Only one direction is likely, and that direction is up. 

One could argue that the Japanese have been doing what we're trying to do -- run up mountains of debt to stimulate the economy -- for decades, and their rates are still very, very low. Then again, their stock market is still down 80% or so from its 1990 peak.

2. Higher taxes

It's tough to buy goods and services (increasing companies' earnings) as well as invest in the stock market (creating demand for shares) when an increasing amount of your money goes to taxes. It's not happening now, but it's coming.

I suppose some taxes are good for stocks -- e.g., taxes that pay for defense enhance the bottom lines of companies like Boeing. But a large portion of taxes will go toward paying interest on debt, which does diddly for the stock market. 

3. Demographics

Another factor behind the bull market of the 1980s and 1990s, according to some folks, was the rise of the baby boomers, who began reaching their peak earning years, stuffing their 401(k)s and IRAs, and bidding up stock prices. But what will happen when the flow goes the other way, and boomers begin selling assets to fund their retirements? Will there be a decades-long bear market?

Probably not, says a 2006 study from the Government Accountability Office, partially because the average boomer doesn't own many stocks, bonds, or mutual funds. In fact, 10% of those born between 1946 and 1964 own two-thirds of the generation's financial assets. One-third of boomers don't own any stocks or bonds.

The GAO supported its conclusion with the following: First, retirees don't sell all their assets at once, but rather scale down gradually over decades. Second, the boomers won't retire all at once; while the oldest boomers turn 63 this year, the youngest group is just 45.

OK, so that sounds reasonable. But I'm still not convinced that the aging of the boomers won't have an effect on the economy. As most people do as they get older, aging baby boomers will spend less and invest in stocks less. 

 

So there you have 'em. You probably have a few more.  The question now is, if stocks will struggle, what's the alternative? Bonds won't do so well in a rising interest rate environment, either. 

Returning to Buffett, he's gone on record many times over the past several months as being a buyer of stocks, and that they'll beat bonds over the next 20 years. And I agree.

But when it comes to retirement planning (which is my bread and butter here at The Motley Fool), I don't think people should count on double-digit returns. 

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