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Why I Was Wrong About 'Dow 36,000'

February 24, 2011 by James K. Glassman

In 1999, I co-authored a book called "Dow 36,000" that became, in some circles, a notorious symbol for bullishness about the stock market. While the book had a provocative title, its fundamental message was mainstream: Long-term investors should load up on U.S. stocks. For most periods of 10 years or more, shares of U.S. companies produced far greater gains than bonds, at much the same risk. Yes, stocks bounced wildly up and down, but your job as an investor was to hang on and collect your reward for perseverance at the end of the ride. So, like most sensible financial advisers, I told readers to tilt their retirement portfolios strongly toward stocks—but with an extra large dollop of optimism because stocks at the time seemed undervalued. I was wrong. Today, the Dow Jones Industrial Average is just 20% higher than it was when "Dow 36,000" was published in September 1999 and the markets stood at 10,318. Even with dividends, annual returns over the past 11 years have been a few piddling percentage points. What happened? The world changed. While history is usually the best guide to the future, it is far from perfect. Judging strictly from history, at the start of 2008 it was hard for many to imagine that an African-American would be elected president (or that the New Orleans Saints would ever win the Super Bowl). The first major change is that the relative economic standing of the U.S. is declining. The Congressional Budget Office estimates that U.S. growth will average a little more than 2% over the next 70 years, compared to about 3.5% during the second half of the 20th century. This is a stunning decline. The reasons? One is a demographic imbalance, with too few workers supporting too many retirees and other non-workers. Another is a growing preference for European-style security. Still others include inefficient investment in human capital, especially K-12 education, and an enormous buildup of debt partly meant to prevent financial catastrophe in 2008-09. Meanwhile, developing nations like China, India and Brazil are growing far faster than the U.S. The second big change involves risk. Along with most investment analysts, I used to consider only one kind of risk: the volatility of an asset's price. While stocks have returned a yearly average of about 10%, their actual returns bounce around from year to year. Intel, for instance, gained 34% in 2007, lost 43% in 2008, and gained 43% in 2009. Still, with a diversified portfolio—for example, the 500 stocks of the Standard & Poor's 500 index— this volatility flattens out over the long term. If you hold such a portfolio for 20 years, then history shows that two-thirds of the time your average yearly returns will fall roughly between 8% and 15%. Not very risky at all. But there is a second kind of risk, the kind that we can't really measure or expect—the murder of 3,000 Americans by terrorists in a single day, the Dow losing 1,000 points within minutes in a "flash crash," or home values in the U.S. suddenly plummeting. These discontinuous risks—or "uncertainties," as the famous University of Chicago economist Frank Knight called them—are multiplying in a world in which technology provides instantaneous connections among markets and allows just about anyone to do just about anything, anywhere. Economic stagnation isn't inevitable. At the Bush Institute, we're supporting and crafting policies, such as freer trade and better schools, aimed at 4% sustainable growth, which would dramatically reduce debt and boost employment. Encouraging substantially more immigration by skilled workers could correct the demographic imbalance. Perhaps I'm wrong about the world being a riskier place. But even if I am, this is still a time for investors to proceed with caution. They can protect themselves against the worst by ratcheting down the proportion of stocks they own compared with bonds, and by buying hedges such as "bear funds," whose prices go up if the market goes down. Such a strategy amounts to paying an insurance premium that reduces your upside a little while reducing your downside a lot. In 2008, for instance, an all-stock portfolio (based on the S&P 500) lost 37%, but a portfolio split 50-50 between stocks and long-term Treasury bonds lost only 10%. In 1997, the all-stock portfolio gained 33% while the 50-50 portfolio returned 25%—still awfully good. This strategy not only fits the reality and danger of our times, it also fits the psychology of investors. Ronald Reagan once said that an economist was someone who watched something work in practice and "wondered if it would work in theory." Well, in practice, stocks have been crushed, and not just in 2008. In theory, historical averages show that stocks are a good buy if you can hang on through the miserable periods. But most investors find that excruciatingly difficult to do—a fact that I never fully appreciated in my 30 years of writing about investing. Fear, or simply a need for cash, triumphs, and people sell before stocks bounce back. I've gotten tired of telling investors to buckle up and hang on. Instead, I am urging them to adopt a more cautious strategy than the conventional financial wisdom—or "Dow 36,000"—would dictate. Mr. Glassman is the author of "Safety Net: The Strategy for De- Risking Your Investments in a Time of Turbulence," just out from Crown Business. He is executive director of the George W. Bush Institute.


Author

James K. Glassman
James K. Glassman

James K. Glassman is the Founding Executive Director of the George W. Bush Institute and the interim Director of the Military Service Initiative.

He served as undersecretary of state for public diplomacy and public affairs from June 2008 to January 2009, leading the government-wide international strategic communications effort. Among his accomplishments at the State Department was bringing new Internet technology to bear on outreach efforts, an approach he christened “Public Diplomacy 2.0.”

From June 2007 to June 2008, Glassman was chairman of the Broadcasting Board of Governors (BBG). He directed all non-military, taxpayer-funded U.S. international broadcasting, including Voice of America, Radio Free Europe, and Alhurra TV.  Glassman was a senior fellow at the American Enterprise Institute in Washington, D.C., from 1996 to 2008, specializing in economics and technology.

He has been moderator of three weekly television programs: Ideas in Action and TechnoPolitics on PBS and Capital Gang Sunday on CNN.

Glassman has had a long career as a journalist and publisher. He served as president of Atlantic Monthly, publisher of the New Republic, executive vice president of U.S. News & World Report, and editor and co-owner of Roll Call, the Congressional newspaper. Between 1993 and 2004, he was a columnist for the Washington Post and the International Herald Tribune and continues to write regularly for Kiplinger’s Personal Finance and Forbes. Shortly after graduating from college, he started Figaro, a weekly newspaper in New Orleans. His articles on finance, economics, and foreign policy have appeared in The New York Times, The Wall Street Journal, the Los Angeles Times, and various other publications.

Glassman has written three books on investing, and in April 2012 was appointed to the Investor Advisory Committee of the U.S. Securities and Exchange Commission. He was formerly a member of the Policy Advisory Board of Intel Corporation and a senior advisor to AT&T Corporation and SAP America, Inc.

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