Tuesday, March 29, 2011
Investing for the Future
Jeremy Siegel’s latest book is an eye-opener. The book may seem old considering it was written in 2004 – way before the economic crises that occurred in 2008 and 2009 when the financial world nearly collapsed. But his ideas are not the usual investment advice that one would expect from finance gurus. It’s a book written by someone with expansive and deep views – with geo political breadth but with the no nonsense investment views of a Benjamin Graham. He seems like a combination of Warren Buffet and the futurist Alvin Toffler. The result is a well thought out and researched book that provides a balanced perspective from both the economic and investment fields. It also contains sound empirical evidence that’s more at home in an economics PhD thesis.
The crux of his book is proposing a ‘Global Solution’ to the current problems in fiscal deficits and health care costs - brought on by the coming retirement of the baby boomers. The retirement of the baby boomers will cause massive disinvestments in the equity and bond markets as money is withdrawn to fund retirements and pay for health care needs. The situation is made difficult with the aging population in developed countries like Europe, Japan and USA. His solution is to have the rising powers in the developing world – India and China take the slack and buy into the equity markets of the developed world especially USA where the stock market has consistently increased one’s wealth. So the ‘Global Solution’ aims to have the emerging powers solve the problem of the developed world especially the possible fall of asset prices.
Looking at it in a different way, India and China (and possibly Indonesia and Brazil) will have a lot of surplus funds since the emerging middle class will have all the jobs outsourced from the developed countries. So the baby boomers of the developed countries will be buying cheap good and services from these emerging countries – transferring immense wealth from West to the East. So the emerging countries now have the money to re-invest in the capital markets of the developed world. The 2008-09 financial crises saw this dynamic at work with Singapore and China coming in to invest in the distressed US financial system. The ‘Global Solution’ is an interesting view on the coming long term crisis. It’s a first class analysis of the current problems that is still applicable after the world changing economic and financial fiasco of 2008 – 2009.
With this in mind, the investor should avoid the ‘growth trap’ of investing in hot, new companies, for example, Google, or Apple or Microsoft. Instead, one should invest on the tried and true companies such as General Electric, Philip Morris (now Altria) and Pfizer. The main reason is that low expectations have driven down the market price of these stocks but these tried and true companies would often maintain their attractive dividend policy and rate of appreciation (due to low market expectations). Philip Morris is one company always mentioned in the book which is counter-intuitive considering the lawsuits from cigarette smoking. Normally, one would not invest in the tobacco sector at all. But Siegel makes the case that these mature companies like Philip Morris would overcome these constraints. In Philip Morris case, diversifying into foods and changing its name to Altria. Hence, Philip Morris is the better investment than IBM – the hot growth stock at the time in the 1950s.
To Siegel, wise investors should focus on companies with good dividends, re-investing those dividends to increase the compounding effect, focus on good valuation relative to earnings or cash flow (good P/E ratios) and on stocks where the expectations of the market have fallen (such as Philip Morris) and to hold them for the long term (preferably forever). He suggests companies with a global foot print and sectors such as health care and staples. To benefit from emerging markets, he suggests investing about 50% on index funds that focus on global companies in the rising countries of India, China, Brazil and Indonesia. For example, companies like WIPRO in India or Lenovo in China. Siegal writes with the style of an old world investor with abundant empirical evidence and an air of academic seriousness. He sounds like an intellectual version of Warren Buffet. One hopes to read his previous book ‘Stocks for the Long Run.’
Yesterday, one also watched the film ‘Inside Job’ – a documentary about the economic and financial crisis of 2008-09. A brilliant film that portrays the lethal combination of financial innovation such as mortgage securitization (and CDOs and CDS), the ideological belief in deregulation and free markets, rise of financial incentives (bonuses) that reward risk and a political system with no control and supervision – all combined to blow–up the financial system. The film also tackled the intellectual foundation (i.e. Ayn Rand) and flawed economic theories that seemingly smart people like Alan Greenspan, Lawrence Sumner, Robert Rubin and other well-known economists and leaders believed in. Popular political leaders such as Ronald Reagan and Bill Clinton are not spared as well. One wonders what is the point of investing wisely when these conditions allow the system to blow up.
In fact, the crisis allowed Siegel’s vision to come to fruit. Chinese and Singaporean sovereign funds came in to invest in troubled banks as well as Japanese and Middle-Eastern funds. The money flows are moving west ward from the East – a trend that started with Japan. Now most of the treasury bills or real estate properties are owned by Chinese, Korean, Japanese and other concerns. A turn of events not even the Tea Party can turn back. It’s like an inevitable march of the rising East. One wonders if the result will be political discord especially with trends like the Hispanic population now being the 2nd largest ethnic group in the country and blacks retuning to the South (for example, Atlanta being the largest city with a black population as compared to Chicago) or Asians being the largest ethnic group in New York (and possible Los Angeles). Demographics are a statistical truth that one cannot deny. One needs to understand what will be the resulting future.