Larry Halverson: I've Been Thinking

Some thoughts on investing . . . and on investors, including myself.

I worry too much. Odds are you worry too much, too. Most of the things we worry about never come to pass. The few that do are rarely as bad as we had feared.

So, if you’re paying attention, you’ve probably caught yourself thinking, “Hey, that wasn’t so bad after all” far more often than, “Wow, that was way worse than I expected.”

I and probably most other stock investors have been experiencing this “wasn’t so bad” thought/feeling a lot lately. I can almost hear a collective “Phew!” as most of our fears from 2006 fade away:

• Energy prices – set a new record high (though not if adjusted for general inflation), but have eased considerably since then
• Inflation – remained well behaved at only slightly above the Fed’s target range
  Fed rate increases – halted mid-year at a not-too-restrictive level, and are likely to trend down from here
• Housing bubble – definitely lost some air, but only slowly, and appears to be stabilizing
• Consumer spending – held up remarkably well (it’s become part of our culture)
• Corporate profits – actually expanded further (we do capitalism very well), but could fade some with the slowing economy
• Weather – no global warming-induced repeat of 2005’s hurricane season

Overall economic growth – slowing, but still the not-too-hot, not-too-cold “Goldilocks” economy investors love.

So, the late-2005 consensus expectation for mid- to high-single-digit stock returns in 2006 was only about half right – we got twice that amount (the S&P 500 for example gained more than 15%, and the Dow nearly 17% to new highs) as our fears proved to be excessive. And, we all wish we would have owned more stocks!

Now, the consensus expectation for stock returns in 2007 is . . . mid- to high-single-digits. Again. And again, it’s likely to be wrong. Again, too conservative. Besides all the favorable factors noted above, stocks should benefit from some other potentially even more powerful influences:

• Valuation – Stock prices rose in 2006, but for many companies, earnings advanced even more. So, average P/E multiples are lower than a year ago. The S&P 500 is selling for about 15 times 2007 expected earnings. This is below the historical average and well below the levels that have typically prevailed when interest rates and inflation were as low as they are currently. Unless inflation and interest rates turn up significantly, P/Es should expand as we move through 2007.
• Supply and demand – Companies have been buying back their own stock and acquiring other companies, reducing the supply of stocks and putting money to reinvest into the hands of stock investors. This supply/demand imbalance is expected to grow even more in 2007.
• Weak dollar – The lower dollar makes our nation’s exports less expensive to buyers in countries with stronger currencies, aiding our economic growth, which helps sustain employment levels, which provides support to consumer spending, which can’t help but buoy stocks.

Global liquidity – The world is awash in liquidity, much of it in the form of U. S. dollars, reflecting our trade deficit, broad global economic growth and excess global saving (the saving rate in China is 40%!). This will help keep inflation and interest rates low, fostering higher valuations for stocks.

So, no worries? Of course not. We still have limited and vulnerable energy supplies, falling home prices in many areas, uncertainty from the coming change of leadership in Washington (regarding tax increases, new regulations, trade restrictions, etc.), terrorism threats, natural disasters, epidemics . . . the list goes on. And, in spite of those who contend that “it’s different this time,” the market almost never goes five years without a cyclical sell-off. And, periods of low stock and bond price volatility and of increasing Fed funds rates (we’ve had both for some time now) are almost always followed by weak markets.

So, sure, we could well see a market set-back sometime in 2007. But, we both know that few if any of the many risks on the horizon will actually occur. And, any that do are likely to cause fewer and milder and more temporary problems than we expect. So, the environment for stock investors is likely to be better than we expect.

Because we worry too much.

So, let’s lighten up. Or, at least let’s acknowledge our innate tendencies to overemphasize the potential negatives.

Then, maybe we can more often invest right even though we so often think wrong.


(Next time, unless something better comes to mind, I’ll share my views as to which investment categories appear the most and least attractive as we head into 2007. Sometime, though, I want to touch on why (besides our natural negativism) we humans are often such poor investors. Also, I’ve found myself thinking a lot lately about aspects of retirement other than things financial, which gets into some areas I may be totally unprepared for. Scary stuff! Later.)