My Brother Is Only Slightly More Comforting than Ben Bernanke

by Brian Pierce • Mar 17th, 2008 at 12:23 pm •

This is a brief e-mail exchange between me and my brother, who is in the process of getting his MBA at Washington University in St. Louis:

Date: Mon, 17 Mar 2008 at 2:13 PM
From: Brian
To: Greg
Subject: a question on the economy

Are we all going to die?

Date: Mon, 17 Mar 2008 at 2:19 PM
From: Greg
To: Brian
Subject: RE: a question on the economy

short answer: no.

Anybody else have any other expert analysis? I’m kinda freakin’ out.

Update: Okay, he just redeemed himself a little:

Date: Mon, 17 Mar 2008 at 2:44 PM
From: Greg
To: Brian
Subject: RE: a question on the economy

Longer answer: This would seem to be a similar situation to the early 1990s recession. In both cases there was trouble in banking and real estate (S&Ls in the 1980s-90s, Sub-Prime Today), followed by a minor decrease in the GDP (about -3% in the 8 month long 1991 recession).

All in all, this is good for us (you and I, not the general world). One way companies save money is getting rid of older (and expensive) employees and replacing them with young (cheap) employees (see http://www.chicagotribune.com/news/chi-sun-grads-hiring-genxmar16,0,7109193.story ). Secondly, investing long-term right now is a good idea (buy low, sell high). So the money we invest in the next few years will grow a lot by the time we are buying houses or retiring.

Still, I hear things like Alan Greenspan saying, “The current financial crisis in the US is likely to be judged in retrospect as the most wrenching since the end of the second world war,” and I get nervous. Am I just panicking?

Also, while it may be good for people like my brother and me, it’s bad for a lot of other people, right? What do we do about it? Bail out the banking people? No? I don’t know anything!!

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There Are 7 Responses So Far. »

  1. Comment by thetodd on 17 March 2008 at 2:06 pm:

    What makes him think that now is any better than any other time to invest?

    It sounds to me like he may be reasoning that the market is currently undervalued simply because it is lower than it once was. The market surely has some inefficiencies, but it does not have any gapingly huge inefficiencies with simple exploitation strategies like “buy if the market is lower than it once was”.

  2. Comment by Greg on 17 March 2008 at 3:43 pm:

    Because the market trends upwards. As a point of comparison, investing $100 in the S&P 500 in November 1991 (Recession) would yield $147 5 years later. Doing the same in 1998 (High Growth year) would yield only $103 5 years later. Granted the longer term you go the less the impact current market conditions have. (If you think I am cherry picking, you can use Yahoo! Finance to get historical adjusted S&P 500 prices.)

    Therefore unless you assume that the market will never begin growing again (not even for population growth), buying at a low price insures a bigger return than buying at a high price.

    This does not indicate an inefficiency because buying now requires an investor to have to wait to get a return on a stock; whereas when the economy is good investors get instant gratification (high dividends) for which they must pay a premium.

    Think of it this way. If you promise to pay me $10 tomorrow, I will happily give you $9.50 today. Whereas if you promise to pay be $10 (inflation adjusted) in 2 years, I would not be willing to pay nearly as much (let’s say $5). We have moved from situation 1 to situation 2. Situation 2 favors people who save today (i.e. the young) at the expense of those who spend money today (retirees and home buyers).

  3. Comment by thetodd on 17 March 2008 at 4:26 pm:

    Greg,

    Thanks for coming over here and responding.

    I agree that if you assume the axiom “the market trends upwards”, then any time (now included) is a good time to invest.

    I just thought that you may have been making a claim that equities are currently underpriced. I’m still not sure if you are saying this or not. If you are expecting to get real returns significantly greater than real GDP growth without taking on much downside risk, then I think you are essentially saying that equities are mispriced.

  4. Comment by tet on 17 March 2008 at 4:33 pm:

    Actually, though, there have been extreme periods in the past that bucked the general trend.

    If you had invested $1000 in the market in June of 1929, you would have had to wait until 1954 for the market to rise enough to get your money back (adjusted for inflation, of course).

    You might amend your statement to “the market trends upwards most of the time with an occasional extreme correction downwards.”

    Todd, anytime in the mid-to-late 1920s would have been a horrible time to invest long-term, so that demonstrably counters your axiom.

    Tom

  5. Comment by thetodd on 17 March 2008 at 4:46 pm:

    Not my axiom :)

    My axiom would be something more like “market trends to GDP”. GDP has risen pretty quickly since the industrial revolution (with some weak periods like the one you mentioned), and most expect continued long-term GDP growth, so the simpler “market trends upward” idea is probably not too far off, and it’s a useful idea because it’s easier for people with no economics background to understand.

    I expect continued long-term GDP growth. Short-term? The next couple of years? I don’t know.

  6. Comment by Gregory Pierce on 17 March 2008 at 6:12 pm:

    The market and GDP measure pretty much the same thing. THe market being the value of all publicly traded companies. GDP being the value of goods and services (provided mostly by those publicly traded companies) produced in the US.

  7. Comment by Anonymous on 18 March 2008 at 1:56 pm:

    When investors are gripped by fear is typically the best time to invest. When they say that everything is great, it’s time to sell. Currently stocks are selling on average at P/E ratios below they historic averages. That means that at some point, investors will likely consider them undervalued versus the risk associated with owning stocks.

    In the long term, the stock market is the only place where you can expect to have returns higher than the rate of inflation.

    It is scary right now to own stocks. There is no certainty that we won’t suffer another depression. But history says we will likely survive this one as we have all the earlier downturns. I just wish that the greed and unrealistic expectations had not occurred.

    Housing will not always increase in value. The use of leveraged debt investments (SIVs and CDOs) that multiply both potential gains and losses should not have reached the level they did.

    Banks and mortgage buyers created this mess. It’s unfortunate we have to bail them out.

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