Long Term, We Won't Be Left Behind

by Stephen Butler

I don't think the current economic malaise is a canary in the mineshaft signaling the "End Times," as some religion-oriented economic web-sites have proposed. More secular economists have predicted a recession like we had in the early 1980's. If so, a review of the past and its effect on the stock market could offer a glimpse into the future.

The economy was basically in a mess during the late 70's with a phenomenon of "stagflation" which is a combination of high inflation and a stagnant economy. Meanwhile, the stock market marched to its own drummer during that period as it plunged by 32 percent in '73 and '74 but recovered to a 4 percent gain by the end of '76. As the stock market was plunging, inflation hit about 12%. A few years later, in 1980, inflation was about 15 percent for the year. The economy imploded in '82 with bankruptcies increasing by 50 percent.

So what was the market doing? From 1979 through 1985, the S&P 500 index gained at a rate of 14 percent per year not counting reinvested dividends. The largest five hundred companies represent seventy percent of all publicly-traded stock, so this index is essentially the stock market. It's also an index that few stock pickers ever consistently beat.

As the early '80's rolled along, Ronald Reagan became president and launched three major fiscal events. He raised taxes on Social Security and impacted every single worker and employer. It amounted to the greatest single tax increase in history. At the same time, he reduced income tax rates at higher income levels, and he started borrowing huge amounts of money to fund military spending. The premise at the time was that "deficits didn't matter." As the decade continued, the economy turned around, but the stock market, since the late seventies, had long since started its march toward its greatest sustained increase in history --- a march that continued right through the 1982 recession and that ended with a 25 percent drop in a single day in October of 1987.

The stock market often performs in ways that are not necessarily in lock step with economic conditions. To try to second guess what might happen next is a mistake that leads to disaster for most novice investors. The "invisible hand" of economic forces rewards people who stay invested in stocks over long periods, because socio-economic forces reward confidence. Real confidence, as opposed to false confidence, is generally well rewarded. Think about our highly-paid brain surgeons, defense attorneys, relief pitchers, entrepreneurs --- these are all people who gain confidence and sell what it produces for lots of money. History illustrates that investors who stay the course can generate the same reward. You too can act just like your favorite relief pitcher when it comes to your 401(k) account.

Given the inability to predict the future, we just need to know that with enough time, we'll make plenty of money on our investments. It may sound simple but it's true. However, the basic rules still apply. The basics include diversification across different investment types, keeping fees as low as possible, choosing funds that have demonstrated superior past performance, rebalancing periodically, and adding bonds or bond funds as we approach retirement.

Meanwhile, we can forget any help from the media when it comes to inspiring confidence. Financial pages and channels are doing their best to whip up hysteria, and they have succeeded if a 40 percent drop in market values is any indication. The economy might be slowing, but the success and momentum that remains is still huge and scheduled to grow again within a few years. These are not the end times, and those of us with confidence and a historical perspective won't be left behind.

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