Investors Beware

Few current investors have suffered through a serious recession or depression. Because one has not occurred in their investing experience, many consider such an event improbable if not impossible. Others do not understand how brutal such an event can become.

Major corrections used to be normal events. Will Bancroft provides a perspective as to their frequency:

This contemporary investor behaviour is contextualised with reference to the work of the economist Professor Robert Barro. Mr Barro’s work finds that although there have been 58 ‘disasters’, a drop in GDP of >10%, in the 20th century, only two occurred post 1950. During this time portfolios positioned for the good times, heavily allocated towards yield and productive investments, have reaped a fine harvest.

Recent experience has conditioned investors to expect up markets and economies. Only two “disasters” occurred in the last fifty years of the twentieth century. But what about the 56 that occurred in the prior half century? What changed to make the incidence of disasters drop from approximately one per year to one every 25 years?

One change is responsible for the difference in these two fifty-year periods — the advent of government economic intervention applying Keynesian macroeconomics. At first glance, the data suggests that is a good thing. After all, the number of Barro defined “disasters” have been reduced to 4% of what used to happen. The interventions have certainly reduced the severity of cycles, at least as measured by government statistics. But, at what cost?

Economic growth and per capita income growth has slowed, except for The Great Depression, which arguably was precipitated by government intervention and then made worse by government remedies. Technological changes in the first half of the last century certainly helped economic performance, but were they any greater than similar advances in the latter half? Economic advances spawned by the internet, military breakthroughs applied to the commercial sector and healthcare breakthroughs were significant, even though there is no objective way of determining which half of the last century was the bigger beneficiary from such advances.

If we zero out technology as a factor between the two periods, then we are left with more disasters in the first period and greater progress as well. Is it possible that the economic disasters as defined by Barro were “purchased” by government intervention and a debt bubble never before seen? Is it possible that all of this tinkering and debt hid the problems which were allowed to become so big that they may destroy the economy?

My guess is that our recent prosperity is little more than a last hurrah. We lived high and well by consuming forward. That is, we borrowed our way to prosperity. Now we must repay this profligacy and our economy and financial markets are going to look horrible for a few decades as this debt is worked off. That is the best scenario I can see.

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