THE MARKETS
Can world governments "cut" their way to prosperity?
It's no secret that many countries are incurring large--and
unsustainable--budget deficits. What's interesting is the approach
each country is taking to try to lower their deficits to a
manageable level. Britain, Japan, Germany, and Greece, for example,
are focused on cutting government spending, according to Bloomberg,
June 22. Conversely, the U.S., while concerned about government
spending, seems more focused on keeping the stimulus spending alive
and raising taxes until (hopefully) the economy can catch fire and
grow on its own.
Who's right?
According to Harvard University professor Alberto Alesina,
"There have been mountains of evidence in which cutting government
spending has been associated with increases in growth, but people
still don't quite get it." In addition, a study by Ben Broadbent
and Kevin Daly of Goldman Sachs Group, Inc. as reported by
Bloomberg on June 22, "discovered that reducing expenditures by 1
percentage point a year boosted average annual growth by 0.6
percentage point. Raising the ratio of taxes to GDP by the same
margin cut growth by an average 0.9 percentage point." And, from a
stock market perspective, the same report said, "The equity markets
of the countries that sliced spending beat those of other advanced
nations by 64% during a three-year period."
Like many things related to finance and economics, we won't know
"who's right" until time passes and the market delivers its
verdict. Between now and then, expect the vigorous debate on
spending cuts versus stimulus spending to continue among academics,
investors, and world leaders.
|
Data as of
3/12/10
|
1-Week
|
Y-T-D
|
1-Year
|
3-Year
|
5-Year
|
10-Year
|
|
Standard & Poor's 500
(Domestic Stocks)
|
-3.6%
|
-3.4%
|
17.0%
|
-10.4%
|
-2.0%
|
-3.0%
|
|
DJ Global ex US
(Foreign Stocks)
|
-2.0
|
-8.6
|
13.9
|
-11.7
|
1.9
|
0.4
|
|
10-year Treasury Note
(Yield Only)
|
3.1
|
N/A
|
3.6
|
5.1
|
3.9
|
6.1
|
|
Gold
(per ounce)
|
-0.2
|
13.6
|
33.8
|
24.4
|
23.3
|
16.0
|
|
DJ-UBS Commodity Index
|
0.2
|
-7.5
|
3.1
|
-8.9
|
-4.2
|
2.1
|
|
DJ Equity All REIT TR Index
|
-3.0
|
11.7
|
65.9
|
-6.7
|
1.7
|
10.6
|
| Notes: S&P 500, DJ Global ex US, Gold, DJ-UBS
Commodity Index returns exclude reinvested dividends (gold does not
pay a dividend) and the three-, five-, and 10-year returns are
annualized; the DJ Equity All REIT TR Index does include reinvested
dividends and the three-, five-, and 10-year returns are
annualized; and the 10-year Treasury Note is simply the yield at
the close of the day on each of the historical time
periods.Sources: Yahoo! Finance, Barron's, djindexes.com, London
Bullion Market Association.Past performance is no guarantee of
future results. Indices are unmanaged and cannot be invested into
directly. N/A means not applicable or not available. |
ARE THE FINANCIAL MARKETS "NORMALLY
DISTRIBUTED" and should you even care? Consider this. The
average height of an American male is 69.4 inches, according to the
National Center for Health Statistics, October 22, 2008. If we
randomly chose 1,000 American males and calculated their average
height, we would likely come up with a number close to 69.4 inches.
Now, in an un-random fashion, let's assume we found an 8-foot tall
man--who is clearly an extreme outlier--and we have him join the
previous group of 1,000. By recalculating the data, we now find the
average height of this group of 1,001 men jumps by a very
underwhelming 0.03 inches. In other words, adding an
extremely tall outlier to this group of average height men had very
little effect on the overall average height of the group. Without
getting too technical and assuming "tall outliers" are just as
likely to be found as "short outliers," we can say the height of
men follows a "bell curve" or a normal distribution.
By contrast, let's consider the average net worth of American
households. According to the Federal Reserve, February 2009, the
average American family had a net worth of $556,300 in 2007. Like
above, if we randomly chose 1,000 families, this group would
probably have an average net worth near $556,300. However, for fun,
let's add Warren Buffett--and his $40 billion net worth--to the
group. Recalculating the data, we find the average net worth of
this group of 1,001 Americans jumps to $40.5 million! Clearly,
adding an extreme outlier to this sample dramatically changed the
average of the sample.
As it relates to the financial markets, do you think their
distribution of returns looks more like the average height of
American men (where an extreme outlier doesn't really affect the
average) or the average net worth of American households (where an
extreme outlier could have an extreme impact)? If you think the
returns in financial markets look like the average height of
American men, but it turns out they behave more like the
average net worth of American households, you could lose a lot
of money. In fact, much of modern portfolio theory is based on the
assumption that financial markets follow a normal distribution,
i.e., they look like the average height of American men.
Unfortunately, experience suggests otherwise.
Warren Buffett-type outliers such as the October 1987 stock
market crash, the 2000-2002 bursting of the internet bubble, the
2007-2009 bear market, the 2008 credit crisis, and last month's
"flash crash," suggest that the financial markets are subject to
large outliers that can significantly affect your financial
well-being. Knowing that, we do our best to try to limit the damage
to your portfolio if one of these outliers occurs during your
investing lifetime.
For your convenience the sources
have been listed below:
www.bloomberg.com/news/2010-06-21/cameron-bets-on-prosperity...
noir.bloomberg.com/apps/news?pid=20601087&sid=aMCa3QIjXm6k
www.cdc.gov/nchs/data/nhsr/nhsr010.pdf
www.safehaven.com/article/17241/whats-the-point-of-macro
www.federalreserve.gov/pubs/bulletin/2009/pdf/scf09.pdf
www.forbes.com/lists/2009/54/rich-list-09_Warren-Buffett_C0R3.html
