Dwight Cass
01/01/2005
Four days before the US presidential election, the Department of Commerce released the last major piece of economic news of the campaign season. Gross domestic product, the agency estimated, was up 3.7 percent (on an annualized basis) in the third quarter. Slower, granted, than the 4.2 percent economists had predicted, but faster than the rate in the previous quarter. Not bad for an economy our size, but certainly not the type of growth that will propel our passive core investment portfolios along at a rate that will maintain and enhance our purchasing power.
As Worth went to press, stock market returns, year to date, were still negative, despite a post-election rally spurred by lower oil prices. The GDP growth rate and stock market indifference highlight a maxim that has been repeated to the point of near-mantrahood by tweedy economists, ponderous private bankers and, especially, publicity-loving, responsibility-dodging bond fund managers: We are in for a long, long stretch of slow, slow growth. Its corollaries are legion: Markets will be range-bound. The twin deficits will weigh on our currency. Fixed income will underperform. The credit cycle is at its peak. Volatility is down; the equity risk premium is rising again. Suddenly, the pundocracy suggests, we are living in Germany—or perhaps the Japan of a decade ago—when all we really want is to be Brazilian.
There is some element of expectations management to all this; our bankers are still trying to wring the last vestiges of late 1990s optimism from our bones so we will react with less emotion when they deliver our 2004 financial statements. Even so, the dismal third-quarter trading results of some of the world’s canniest financial firms indicate that the markets are not offering many opportunities.
Most people understand this; two years of terrible performance, one year of great performance (that few people noticed at the time, since everyone was still licking their wounds) and one year of neutral-to-rotten returns has made realists of most of us. For example, we find alternative investments appealing despite their mind-numbing complexity, their manager’s lack of fiduciary self-awareness, the illiquidity of our stakes and the chest-tightening fees they extract. We may be masochists, but the funds have actually delivered positive (albeit tiny) returns this year. (Most, truth be told, are in negative territory on a real—inflation adjusted—basis, but that nuance is drowned out amidst the grinding of our teeth in anguish over all our other investments being down in both real and net terms.)
With the asset side of our balance sheets limping along, it makes sense to turn our attention to our liabilities. Specifically, with the assistance of our advisors and some conservative investment forecasts, we should be able to ascertain just what sort of burn rate we can sustain before we begin to eat into our capital. If our goal is to grow our fortunes, or at least to maintain their current purchasing power, we may have to curtail our rate of expenditure. Indeed, this was a topic of discussion at a recent meeting sponsored by the Institute for Private Investors. One participant estimated that, given the current investment outlook, a private investor who does not want to erode his or her capital would be constrained to a 3 percent rate of expenditure.
Of course, if maintaining our principal is not a priority, our rate of expenditure can rise. But knowing what rate of outflow our investments will support should help us frame our financial decision making and manage our own expectations. That way, we can await the market’s recovery with some degree of calm.
Dwight Cass
Editor-in-Chief