Once again, an utterly unpredictable event has jolted financial markets and frightened investors. This one occurred in Libya, a sandy nation of six million ruled by a very strange man for more than 40 years. Rebellion swiftly drove global oil prices sharply up and the Dow Jones industrial average down. Better get used to it. We live in an era of shocks to the system, of improbable occurrences that can wreak havoc with your psyche and your 401(k) plan.
Slowly and reluctantly, after three decades writing about finance, I have come to the conclusion that because the world has changed, investment strategy must change with it. The old rulebook, which served us so well for nearly a century, needs revising. The rush of recent bolts from the blue - the attacks of 9/11, the BP oil blowout, the "flash crash" that sent the Dow tumbling 1,000 points in minutes and the unprecedented collapse of U.S. home values - is no fluke. These nasty surprises are a consequence of a world in which technology can have cataclysmic effects - first, by permitting the few to have a huge impact on the lives of millions and, second, by connecting, widely and instantaneously, markets that are often ruled by speculation.
My own chaos theory for investors can be summed up this way: Protect yourself by building a portfolio that reduces your downside risk. You can't do that with an all-stock portfolio, or anything close to it.
Readers of my column in The Washington Post will recognize that this is a change of heart. They remember me as the ultimate proponent of U.S. stocks. My credo was: Buy diversified equities and hold them forever. If you judge from history, you could be confident that, while stocks may decline in the short term, they recover - and then some - in the long term.
My advice after a terrible year like 2008, when the Standard & Poor's 500-stock index lost 37 percent, would have been to suck it up. Don't whine. Don't fret. Just wait until stocks recover. And certainly, stocks have come back. But I now recognize that for most investors, perseverance is hard; the anxiety is just too great. They need a smoother ride, without the roller-coaster dips.
I also believe it's possible that stocks won't come back, as they have not, for instance, in Japan, or on our own Nasdaq. For the broad sweep of U.S. stocks, the future will not necessarily be like the past - first, because the world has become more fraught with danger and volatility, and second, because the United States is in a condition of relative economic decline.
The experts at the Congressional Budget Office, reflecting the conventional wisdom among economists, see sustainable GDP growth (after a brief recovery blip this year and maybe next) at around 2 percent, compared to about 3.5 percent for the second half of the 20th century. Since corporate profits determine stock prices and since those profits are linked to overall growth, we can expect a slowdown in the historic rate of U.S. stock returns.
Read more at The Washington Post.
