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January, 2014


Lookout! Disasters and big market scares are on the way; yet so too great wealth-building opportunities. A look at the last 100 years reveals myriad crises and disasters that at the time might have been disturbing not merely for one's emotional health but also for one's perceived financial well-being.

Since the beginning of 1914 and to 1993, a few of these have included World War I, the 1918 influenza pandemic, the Bolshevik and Russian Revolutions, the Great Mississippi Flood of 1927, the Great Depression, the triple rise of Nazism, Italian fascism, and Japanese imperialism, the Spanish civil war, the Huang He floods in China, World War II, the Holocaust, the Chinese civil war, starvation of tens of millions in China, the birth of the Peoples' Republic of China, the Cold War, the Korean War, the success of Fidel Castro and the Cuban revolution, the Cuban Missile Crisis, the Yom Kippur War, the assassinations of John Kennedy, Martin Luther King, and Robert Kennedy, the Vietnam War, the Arab-Israeli War, Three Mile Island, Mount St. Helens, Chernobyl, the 1991 Bangladesh cyclone, the Gulf War, and the 1992-1993 European Union currency exchange crises.

The October, 2013 "Investment Adviser's Letter to Shareholders," Tweedy, Browne Fund, Inc. (pages I-3 to I-5) points out that during the most recent twenty-year period, 1993 to 2013, quite a number of things occurred which probably caused further distress for the heart and pocket-book alike: the top marginal tax rate was raised in 1993 to almost 40%; Japanese government debt that same year was estimated at 71% of gross domestic product; in 1994, disruptions included commercialization of the internet; 1995 saw a government shutdown due to a budget impasse; 1997 saw an Asian financial crisis (with, on one day, 10/27, the DJIA falling over 7%) plus the return of Hong Kong to China; in 1998, Long-Term Capital Management failed and was bailed out with nearly $4 billion; 1999 saw the rise of crude oil to a high of $26 a barrel; 2000 saw the bursting of the " Bubble;" in 2001, Enron collapsed, our country experienced the 9/11 terrorism, a War on Terrorism was declared, and before long this was broadened to include unfunded wars in Afghanistan and Iraq; in 2002, the NASDAQ, which had achieved an all-time-high of 5133 a few years earlier, fell to 1423; 2004 saw oil costs go to $52 a barrel; 2007 saw a worsening of the U.S. housing crisis and the failures of big Bear Stearns hedge funds; 2008 heralded a worldwide collapse of equity markets, further worsening of the U.S. housing crisis, and initiation of government bailouts for Fannie Mae, Freddie Mac, and several large corporations deemed to be "too big to fail," and total U.S. debt rose to nearly 10 trillion dollars; early 2009 saw equity markets down the most since the Great Depression (though the major averages would rise about 65% from the lows by year's end); in 2010, the Affordable Care Act was passed; in 2011, the Standard and Poors downgraded U.S. debt rating, oil reached $123 a barrel, and Greece, despite bailouts, threatened default on huge levels of indebtedness and considered detaching from the European Union; 2012 saw Europe fall back into recession and U.S. debt reach over 16 trillion dollars; through 2013, U.S. and European interest rates had been kept at historically low levels for several years' running, Japanese government debt had risen to over 200% of the nation's gross domestic product, U.S. debt exceeded 17 trillion dollars, the U.S. government was shut down for 16 days, and U.S. unemployment stayed at about 7% (far greater if the underemployed and those who have given up looking were included).

Considering such a past, a realistic view mandates that we not be too sanguine about the immediate or long-term future. It would surely be foolhardy to envisage that the looming years will be free of such upheavals. On the contrary, we must assume the next generation and century will bring their full shares of calamity, anguish, and financial disruption as well.

Yet, for all that, we can take heart. There is good news too. Despite such challenges, the U.S. gross domestic product (the combined value of all the country's goods and services per year) rose from $294 billion in 1950 to an estimated $16,400 billion (over $16 trillion) by the end of 2013, a compound increase averaging over 7% a year.

It is forecast that dealing with the negative effects of global warming will cost 2% a year on average. Other factors, such as an increasingly aged population plus a slowing of population growth (and hence of consumer demand) will doubtless take some toll on future gross domestic product rise as well. Still, it is hard to imagine that such factors will be more of a headwind against continued growth than were the wars in which our country has been involved the majority of the time over the past several decades. Moreover, as we go forward our economy and peoples likely will still demonstrate the genius for adapting they have in the past. My own best guess is that we shall continue to see a 2% or greater real expansion (above inflation) of gross domestic product through the next several decades.

How might this affect future investment returns?

The Dow Jones Industrial Average stood at 53 in 1914 and at 16,577 as 2013 came to a close, a yearly rate of growth over the past century of about 6%. The broader S&P 500 Index has risen (from the 1957 onset of its current configuration) through the end of last year at an annual compounded total return rate of about 10%. The still smaller-capitalization Russell 2000 has tended to provide returns averaging a bit over 12% a year, though with significantly greater volatility along the way. Averaging the three, domestic stocks have normally returned about 9%.

Per Warren Buffett, in much of the last century the value of all U.S. stocks has stayed in a 40-80% range of GDP. (Currently they are outside that range on the high side, which may indicate overvaluation.)

Assuming that, in contrast to its previously average return of about 7% annually, the GDP in future years will average about 4% (2% growth plus approximately 2% inflation), this still means a rise at about 60% of what it has seen historically. Since stock markets tend to rise and fall within a range above and below the GDP growth rate, it appears reasonable that average stock share investment total returns in future could be reduced to around 5.5% annually (a bit less than 60% of prior average returns). Yet, since currently stock prices are relatively high compared with the GDP, expectations should probably be lowered below that rate as well, perhaps to 5% or a little less. Modest though that figure is, it at least remains positive.

At a 5% annual total return gain, the S&P 500 Index (with dividends reinvested), could increase in the next couple decades from its 2013 end of year level of 1848 to a not unimpressive 4903 by 12/31/2033. One might say, with a glass half-empty outlook, what, only a $3048 gain - including dividends - after all that time!? Yet, when one also considers that in that generational interval we are probably going to experience as many daunting things to shake up the markets as are detailed above for the period since 1993 (or indeed as occurred in any of the twenty-year periods of the past 100 years), one could instead just as well celebrate that, rather than losing one's nest egg, he or she might, by merely investing in index funds that mirror the market, come out of those traumatic times with more than twice what one had at the outset.

Further, if one learns relatively simple techniques for investing in value stocks, ones with low price to book value, price to earnings, or price to cash flow and/or ones with reasonably high dividend and with low debt, significantly better than 5% average annual gains and dividends can likely be achieved.

If in addition one were to intelligently time* when one invests, for example putting larger amounts into equity shares when markets are substantially down, as they seem to be roughly every 2-4 years, this strategy also should give one large benefits in overall long-term total returns.

While there are no guarantees, all things considered and with a bit of homework, even amid a great variety of scary developments affecting stocks and stock mutual funds, an active and cautious investor might well see compounded long-term annual results of about 10% or above, pretty good for a time of catastrophe. Happy Valentine's!

[*I know of no practical way to time the markets in advance. However, if one will keep lower risk assets available to be redeemed following steep market drops, the proceeds can be used to then buy up shares at bargain prices after the fact. This type of intelligent timing can be very lucrative.]


Larry is not a professional. Don't take him seriously!

Actually, the investment article provided here is for general information only and should not be considered as professional advice, a solicitation to buy or sell any security, or the Word of God. Investors are encouraged to do their own research while considering their personal goals and circumstances, or consult their own professional financial advisors, before making investment decisions. Neither Larry nor LARVALBUG will be liable for any losses sustained by any visitor to this site.

(Disclosure statement: Larry and Val have holdings in some of the suggested assets but do not "make a market" in any of them and do not derive any direct benefit from recommending them, except perhaps for a bit of smug self-satisfaction.)

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