Not Scared of Bears

Jonathan Clements

I HAVE NO IDEA HOW stocks will perform this year or next. But I have full confidence that a globally diversified stock portfolio will fare just fine over the decades ahead.

My optimism, it seems, isn’t shared by many HumbleDollar readers, who fear we’re facing some rough years for the economy and the stock market. How do I justify my optimism about the long term? Here are five reasons.

1. Heads I win, tails we all lose. As I’ve noted before, I view betting on the stock market as an asymmetrical bet. If all goes well, stocks win. If things go terribly, all investments could potentially lose—bonds, cash investments, alternatives, you name it. If we get economic apocalypse, nobody’s going to want your American Eagle gold coins, and they certainly won’t want your bitcoin.

To be sure, the future isn’t limited to two alternatives, either continued economic growth or economic apocalypse. Conceivably, the economy could stagnate, generating no long-term growth. In such a scenario, holders of bonds and cash investments might still get paid, even as stocks plunge in value. Still, while it’s entirely possible that we’ll have a brief period of no growth—after all, real GDP shrank in 2009 and 2020—I think it’s highly unlikely this would continue long-term. How can I be so sure? That brings me to my next point.

2. Humans strive relentlessly to improve their lot in life. When Hurricane Irma hit the Florida Keys in 2017, 25% of homes were destroyed and another 65% suffered major damage, according to the initial assessment by the Federal Emergency Management Agency. Did residents give up in despair? Far from it. Three years later, when I drove down to Key West with my sister, the Keys were back to business as usual.

But perhaps my favorite example is 2020’s pandemic. Not only was it astonishing how fast a vaccine was developed, but also businesses large and small adapted with remarkable speed to a world where folks were leery of close contact with one another. Welcome to Zoom calls, online Peloton classes, outdoor dining and contact-less payment systems.

3. If the economy keeps growing, stocks should keep rising. Vanguard Group founder Jack Bogle would occasionally offer his forecast for U.S. stock market returns over the next 10 years using three inputs: starting dividend yield, expected growth in earnings per share, and changes in the market’s price-earnings (P/E) ratio.

Along those lines, suppose we add today’s S&P 500 dividend yield of 1.4% to the 6.7% annualized growth in earnings per share for the past 10 years. Result? We might be looking at stock market returns of just over 8% a year. But what if investor sentiment turns sour, driving down today’s lofty P/E ratio of 28?

Let’s say the S&P 500’s P/E falls to 20, which is the 50-year average. If that happens over 10 years, it would knock 3.3 percentage points a year off the market’s total return, leaving investors with some 5% a year, slightly better than today’s 10-year Treasury notes will deliver. What if this “multiple contraction” takes place over 20 years? The annual hit would be 1.7 percentage points.

The lesson: Investor sentiment isn’t that important to long-term investors, and the longer your time horizon, the less important it becomes. Instead, what matters is growth in earnings per share. As long as the economy keeps humming along and investors hang tough, they should fare just fine.

4. If the economy malfunctions, the government will pull out all the stops. Have you heard that it took 25 years for the Dow Jones Industrial Average to return to the high notched in 1929, just prior to the Great Depression? If you calculate after-inflation returns and include dividends, it turns out that investors who bought at the 1929 peak would have broken even by late 1936.

More important, the economic hit could have been shortened and softened if politicians and policymakers hadn’t initially pursued tight fiscal and monetary policies. Those policies made the Great Depression so much worse. Today, by contrast, politicians and policymakers may not get it exactly right, but they have a far better idea of how to handle such situations.

In his book Deep Risk, Bill Bernstein points to four such risks—deflation, inflation, confiscation and devastation. These are Bernstein’s four horsemen of the economic apocalypse, all of which could do major, permanent damage to your portfolio. Confiscation and devastation—think an overthrow of our democracy or war on U.S. soil—could destroy the value of all investments, whether stocks, bonds or cash. In such scenarios, not much would help beyond an ample supply of food, fuel and ammo. A well-stocked wine cellar might also come in handy.

But what about the other two risks, deflation and inflation? The folks in Washington are keenly aware of both. In late 2008 and early 2020, they moved quickly to head off the risk of deflation. In 2022, they again moved decisively, this time to throttle escalating inflation. All three episodes were a messy business, and clearly 2022’s inflationary surge hasn’t yet been fully stamped out. But without Washington’s intervention, it would have been a whole lot worse.

5. It’s a big world—fortunately. In February, Japanese stocks notched an all-time high for the first time in 34 years. The country’s painfully protracted bear market isn’t a reason to be fearful of the Japanese market. Rather, it’s a reason to avoid investing heavily in any one country’s stock market.

That’s why my core holding is Vanguard Total World Stock Index Fund (symbols: VTWAX and VT), which replicates the global stock market’s weightings and currently has some 38% in foreign stocks. To many U.S. investors, that seems like far too much abroad. To me—faced with the slim possibility that the U.S. could suffer its own protracted bear market—it seems like it might be too little. But I’m not inclined to stray from the global stock market’s weightings. I may be an optimist—but I’m not optimistic that I can outguess the financial markets.

Jonathan Clements is the founder and editor of HumbleDollar. Follow him on X @ClementsMoney, on Facebook and on Threads, and check out his earlier articles.

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