Stock markets are soaring, but there’s plenty to worry about, including conflicts and all-out wars breaking out around the world and a close and contentious election in the United States.
At times like these, market history can be a source of comfort, at least to some extent.
Relying on history for investment wisdom assumes that the future will be similar to the past. For the past century or so, that has been the correct assumption in the United States. From 1926 to 2023, large-cap U.S. stocks returned 10.3% annually, according to financial services firm Morningstar. The stock market has provided spectacular returns to those who have been able to prevail despite the turmoil and declines associated with wars, recessions, the Great Depression, and extreme political conflict.
This history is essentially why I prefer proven strategies. My strategy is to buy a wide range of stocks and bonds and hold onto them no matter what happens, without letting politics or global crises interfere with my investment decisions.
However, my central assumption that stock and bond markets are no different this time could be wrong. Significant breaks in history can occur when countries are devastated by economic collapse, war, or extreme political change.
Both sides of the presidential race have warned that the race could lead the country down a dangerous path if the wrong candidate wins. Since this is a financial column, I will not evaluate the merits of those claims here. I am simply acknowledging that there are serious concerns in the air. I take these issues seriously, but I’m also an optimist enough to believe that regardless of the winner, the market and economy will eventually trend upward.
But I could be wrong. And if you’re drawn to dire predictions, you may find my no-frills approach to investing unsatisfying.
So here we look at some research on what happened during truly extreme disasters, such as wars and depressions, that resulted in decades of market losses. There is no shortage of dire situations to consider.
war and other disasters
The best study I’ve read on this topic was published in 2008 by Burton Biggs, a prominent hedge fund strategist, longtime Morgan Stanley executive, and meticulous researcher. “Wealth, War, and Wisdom” was published. I spoke with him several times about his work before he passed away in 2012. I think it’s a fascinating but disheartening, excellent discussion of the dire economic consequences we all want to avoid.
Mr. Biggs investigated the performance of stock and bond markets and alternative assets such as gold, food, art, and real estate when and where severe disasters occur. These include Germany and Japan in the first half of the 20th century and immediately after World War II. France, Belgium, and the Netherlands after Nazi Germany conquered them. and America and Britain during the Great Depression.
That’s tough. And I think it’s painful to focus solely on finance when millions of people are suffering and dying. But let’s try it out.
As Mr. Biggs pointed out, the German stock market flourished for a time during the Nazi era, but its inflation-adjusted cumulative return from 1900 to 1949 was -60%. Bonds fared even worse, with a total decline of 98% after inflation. The numbers for Japan and France, which were devastated by World War I and dominated by Germany in World War II, were also terrible.
In such a situation, Biggs said, it is better to leave the country and leave your gold, diamonds, food, identity documents and weapons than to invest in the local stock or bond market (at least in Europe and Japan). (until reconstruction began). World War II caused a financial boom). In Nazi Germany, even if you were wealthy and well-prepared, if you were Jewish, homosexual, Roma, or a member of any other persecuted group, you had to be lucky to survive.
Mr. Biggs investigated various disasters and found no panacea. When a country’s economic and political security collapses, no single investment is always the winner.
But secluded rural retreats are often valuable and can be a lifesaver if you get to them quickly. He concluded that wealthy, risk-averse tycoons in the eastern United States would be better off owning a well-stocked retreat in the foothills of Vermont than maintaining luxury real estate in the New Zealand wilderness. reached.
Mr. Biggs’ audience was limited and truly wealthy. He didn’t write for people with modest resources.
Despite the bleak results of his research, Biggs remained bullish on the U.S. stock market. Even during the worst of the financial crisis in 2008, he expected stocks to eventually outperform other assets.
“As a natural optimist, I believe in stocks,” he once wrote. “Essentially, in the long run, you want to be an owner rather than a lender. But you always have to keep in mind that this time might really be different.”
Lessons from the farm
I think most of us only need stocks, bonds, and cash (including money market funds and government-insured savings accounts) in our portfolios. However, hedging is available to those seeking protection against certain known risks.
For example, farmers always know that one more crop failure could spell disaster. If a good harvest means survival and a bad harvest could mean extinction, it makes sense to hedge by buying futures contracts that will cushion the pain if your crop is disappointing. Masu.
Classic hedging like this, the basis of modern commodity markets, comes at a cost. It’s not just the cost of purchasing the contract. You are essentially betting on yourself, reducing your profits in exchange for insurance against risk.
In modern markets, it is possible to hedge against almost all current financial risks, such as the possibility of another outbreak of violent inflation or a sudden increase in the federal debt. In the case of inflation, you might want to try Treasury Inflation-Protected Securities (TIPS). When it comes to debt, there is a credit default swap market that estimates the likelihood that a sovereign nation like the United States will be unable to pay its debts.
Assessing the severity of a hazard you may be facing and balancing that risk against the cost of hedging is an art form that I study, but don’t practice on a daily basis. .
I also have never bet on the outcome of an election through a prediction market. Such markets can be used to directly avoid election risk. For example, Kalsi currently makes such bets legally in the United States. There is also Polymarket, which only accepts cryptocurrencies. Polymarket and many other offshore gambling markets are, at least in theory, restricted to people who do not live in this country.
With prediction markets, you don’t have to bet on who you want to win or who you believe will win. If you’re hedging against what you think is a significant risk, you can put your money in the hands of someone you don’t want to win. That way, even if the election result appears to be a disaster, what is considered a national loss will be compensated.
Again, if the sky doesn’t fall, you’ve wasted your money. It might be better to focus on helping better candidates win.
Hedging and prediction markets are certainly worth knowing about, but I believe that when it comes to economic well-being, simple strategies are better for most people, as long as the great American experiment continues. Masu.
I am a man of faith and assume that history will unfold along the largely fortunate path that it has followed for so long. I don’t own any gold bullion, bomb-proof safe houses, or shotguns, and I don’t trade contracts in election prediction markets.
For peace of mind, I keep food, coffee, and wine in my house. And as the election approaches, I’m investing for the distant future.
My portfolio is filled with low-cost index funds that include a treasure trove of stocks and bonds, including a wealth of U.S. Treasuries. I expect these to continue to be a major financial ‘safe haven’ for the world.
