Friday, December 28, 2018

Why it pays to be an optimistic investor

One of the most difficult things for investors to deal with is to buy near the bottom of a bear market. It is when pessimism often peaks, and others may look at you when you buy as if you are a crazy nut with rose colored glasses on.  To be honest, even the best investors feel a knot in their stomach when buying at these moments. But as Rick Rule states: You can be a contrarian or a victim. This is not only true for commodity investors but for all asset classes.  Another saying by Steve Sjuggerud is: Buy when an asset is most hated and in an uptrend. 

Historically we have more bull markets than bear markets, because over time markets go up just like the world economy has grown now for nearly eternity and especially during the last century or so. Why has the economy been growing?  Simple the world population has grown most over that last century and it is likely to grow a lot more. All those people add to demand for energy and add more CO2 in the atmosphere (and other environment impacts) and... they will add more prosperity. As long as there are still billions of people wanting to become prosperous there are markets that will grow; there will be new inventions and productivity gains and there will be rising profits and rising stock markets. It is as simple as that!

It is unlikely that the world’s economy contracts before the planet’s population peaks and all those new comers have reached at least a middle-class type of prosperity. Now say the world economy from here on forward grows by 3% per year (an OECD average for the last decades). Then corporate profits will increase at a compound rate of 3% over the next, say 50 years or it will grow by: 438% (the world economy should in theory more than quadruple). Say today’s DOW represents the world economy and it is now 22,000 then it should be at least around 97,000 within 50 years now add inflation and the Dow may be at: 684,000.  Anyone who wishes to invest in stocks?  Look at the chart below showing the relation between GDP and the Dow Jones.



Now, you must realize that this relation is not perfect. During recessions people are pessimistic and value an investment very little. In 1983, just after the 1982 recession the P/E was around 8. During the frothy days of the High-Tech bubble it was nearly 30x earnings and on average it is 16x. GDP occasionally contracts with 2 successive quarters of GDP contraction we call that a recession. Since 1850 we have experienced about 32 recessions, i.e. one every 5 or so years. The Bible talks about 7 good and 7 bad years. Sounds kind of similar to me.

So let’s use Jeremy Siegel’s rule based on past performance: Stocks return per year 7% plus inflation. There is no reason for that to stop now when the number of people that will lead a middle-class lifestyle is about to double! I guess, recessions in this perpetual bull market look to me like 'Buying Opportunities'! I grew up in the Netherlands of the 1950 – 1960s. If I look at my hometown today, I don’t recognize much of it. I am sure I won’t recognize much of how it is today after another 50 years either!!! If you have today $10,000 to invest and you put it in a fairly valued stock market ETF such as that tracking the Dow, then in 50 years you likely own:  $294,000 (provided we don't have Bitcoin as the world's reserve currency 😊)

I have no idea how we will achieve that, but it has been done before through hard work and innovation. That is nothing new for humanity. Just let’s pray that we don’t invent interstellar travel within 50 years because then our growth is limitless!

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