Brief Summary of Ideas Presented
With the election over, it appears we may be about to embark on a “new era” of higher taxes. Is such an assessment correct? And if so, the question remains will this change the investment dynamic argue for changes in the way you should think of your different investments? These are the questions I will attempt to tackle in this article.
Will Tax Increases Lead to Changes in the Outlook for Different Investments?
Of course, nothing can be said with certainty until Congress and President Obama agree on changes, or in what I perceive as a long shot, do not act in December and thus precipitate the “fiscal cliff” (but perhaps only temporarily). However, I believe that investors should be skeptical whenever it is proclaimed that we are entering a “new era” with broad implications for longer-term investing. Likewise, they should exercise caution, even after whatever changes are finally announced, that they themselves (or even some expert) can figure out what adjustments they might be able to make to their investments to either potentially profit from the changes or avoid potential losses. One only need look at prior examples of this “big changes ahead, savvy investors should react” thinking to see why.
The “New Normal” Hasn’t Turned Out Bad as Many Expected
Back in June 2009, investment guru Bill Gross used the phrase “New Normal” to describe the anticipated reduced global growth prospects and what he felt would be considerably lower rates of return for stock and bond investors. He argued that an investor should probably follow humorist Will Rogers who said “he wasn’t as much concerned about the return on his money as the return of his money.” If one had followed such an approach, as many did, and gone into the most conservative investments designed to avoid losses at all costs, the growth of their portfolio would have indeed suffered.
While Gross may have gotten his economic forecast for growth correct, his pronouncement of reduced investment returns has proven way off the mark over the last 3+ years. If we look at the return of the S&P 500 Index over the 3 years that followed, from July 1, 2009 through June 30 2012, we see that the Index returned an annualized 16.4%, way ahead of its 10 year annualized return through the latter date of only 5.3%. And what about returns on bond funds, his specific area of expertise as manager of the world’s biggest bond fund, Pimco Total Return? The 3 year annualized return for all taxable bond funds for the same period, as reported in the Wall Street Journal, was 8.1% as compared to the 10 year annualized return of only 5.3%.
Near Zero Interest Rates and Quantitative Easing Did Not Lead to Excess Inflation
Drastic actions by the Fed in response to the financial crisis began in Dec. 2008, which included a zero Fed funds rate and quantitative easing (QE). This too led some to the view that big changes were afoot, this time with regard to inflation if the policies were not halted quickly. Specifically, prominent economists strongly feared a tide of unwanted inflation or even hyperinflation. In fact, several Fed Committee members themselves have long argued that position. Specifically, back in July 2009, Federal Reserve Bank of Philadelphia President Charles Plosser said in an interview: “I think we will probably have to begin raising rates sometime in the not-too-distant future [to prevent inflation].”
Another Fed participant, Dallas Fed official Richard Fisher, has also argued against the Fed’s easy money policy, also going back to the same time period. Ditto for Richmond Fed President Jeffrey Lacker who said in Aug. 2009 it might be time to pullback from QE. The argument was further promoted to the public by several media-savvy individuals and economists including former Fox News commentator Glenn Beck, not to mention a few prominent politicians.
Of course, higher inflation would have meant higher interest rates, and as a result, poor returns on most types of bonds, and likely stocks as well, something many of this argument’s adherents pointed out. Yet fears of inflation taking off have completely failed to materialize. As noted above, bonds have done quite well under quantitative easing, in some cases even outperforming stocks over the last three years. Inflation-protected bonds have done pretty well too, but not as well as various other categories of bonds, a result contrary to what would have been predicted by those who believed the inflation hawks.