Thursday, December 22, 2005

Brad de Long on why the last decade has been so good to investors

Why was Shiller wrong? In an arithmetic sense, we can point to three factors, each of which can take roughly one-third the credit for real American stock returns of 6% per year over the past decade rather than zero:

  • 2% per year because the acceleration of productivity growth produced by the high-tech revolutions behind the very real "new economy" has made American companies much more productive.
  • 2% per year because of shifts in the distribution of income away from labor and toward capital that have boosted corporate profits as a share of production.
  • 2% per year because the argument of Glasman and Hassett in Dow 36000 turned out to be only nineteen-twentieths wrong: they argued that increasing risk tolerance on the part of stock market investors would raise long-run price-earnings ratios by 400%; it actually appears that increasing risk tolerance has raised long-run price-earnings ratios by 20% or so.
The safest thing to do is what the long run investors have always advocated --- stay fully invested, diversify your holdings to protect yourself, and stick to your plan. If you have done so for the last decade, congratulations, you have now beat out famous economists like Robert Shiller. I will note that Shiller is now running around talking about how overpriced housing is (and it is indeed extremely overpriced compared to historical norms). It is very likely that Robert is correct for a number of reasons, but again, it's a risky bet to sell your house and rent, so I'd have a hard time doing that as well.

I will note that Brad gave great investment advice that has since returned better than 40% at the beginning of this year, and I wish I'd put more money in that asset. Some macro-economic trends are both obvious, and easy to place bets on.
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