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What Role Should the Economy Play on Your Investments?



June 09, 2007 – Comments (1)

The truth is that there will always be negative factors with the economy. Housing isn't doing well, people want interest rate cuts (which I don't understand why - companies have record amounts of cash, rate cuts aren't really necessary at this point, in my opinion), one could go on and on finding negative factors with everything. I believe it simply isn't worth trying to analyze the economy to figure out where it is going. It's also why investors shouldn't weigh too much on the economy to decide what their investments should be. Warren Buffett has stated that he and Munger don't let macro events affect their investment decisions. In other words, if they see a great business, they're not going to let speculation on interest rates or treasury yields keep them from investing or buying it. If you let the economy play too much of a role in your investing decisions, you might as well stick with bonds or a much more conservative, know-you-won't-lose money approach. The bottom line is that there will always be risk associated with the economy, it's never going to be perfect.

This is the main reason I don't follow economist Robert Shiller with as much interest as I once did. He is brilliant at gathering and analyzing economic data, but he is so darn pessimistic. He always finds some piece of data that shows the economy or stock market is in bad shape. In the latest edition of Irrational Exuberance (which I believe was in 2004), he states that he basically sees a lot of downside with stocks. He's been pessimistic on the market ever since that point, mainly because the P/E was leaning to the high side. He's great at finding data and explaining it, but he hardly looks at the other side of things. Over the past few years, companies have built up large amounts of cash, earnings have grown at a nice pace, I don't think a P/E on the higher side is unjustified as much as he thinks. If things for corporate America are going well (and as far as I know since 2004 they have), investors usually are willing to pay a premium for stocks. Sometimes they'll take it to the extreme in both directions, but generally if things are going well they are willing to pay a little more of a premium. Shiller has focused on the negative aspects on virtually everything, and as a result he's missed out on a nice run in the stock market over the past several years.

Over the past 100+ years, the S&P has returned approximately 12% annually going through a depression, several stock market crashes, economic downturns, two world wars, president assassinations and deaths, it goes on and on. We have been through so much, yet have recovered every time. That is why I think Peter Lynch is someone every investor should know about. He says that if you have money you can stash away for 10+ years, put it in stocks. He's absolutely right. The only ten year period at the start of each decade (1900, 1910, etc.) that stocks have underperformed bonds was 1930-1940. Basically, it took a depression, stock market crash, and a world war to make bonds the superior investment during that ten year period. In other words, if you have cash you can keep invested for at least ten years, when you put that money in stocks and keep it there for ten years, your odds of making money are very high. The part where people stumble is when they let short-term movements or impatience become a factor in their investing decisions. If you find a wonderful business trading at a reasonable price, if you buy the stock and hold it for ten years or more there's a very good chance you'll have satisfactory returns. People say they are long-term investors but if the stock hasn't done much after one year they decide to dump it. If the company is doing well yet the market currently isn't reflecting the performance in the stock price, it eventually will. Benjamin Graham said it perfectly:

"In the short-term the market is a voting machine, in the long-term it is a weighing machine." 

If you find great businesses trading at reasonable prices, don't let a short-term sell-off or upward movement affect your decision to hold the stock. Buy and sell based on the business, not the stock.

1 Comments – Post Your Own

#1) On June 09, 2007 at 8:35 PM, dwot (28.95) wrote:

Very well written and well throught out David!

 Some of those economic concerns are looking more significant to me today than even a year ago.


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