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Mar. 2009 – Socialist Fears and the Stock Market

Since last November’s election we have heard from many investors who are unnerved at the prospect of a socialist future. Indeed an enormous expansion of federal spending is underway and ambitious plans have been hatched for greater government involvement in healthcare, energy and in other sectors. Newsweek magazine recently went so far as to announce on its cover that “We are All Socialists Now.” However, the fact that the stock market has fallen precipitously since Election Day is no reason to abandon stocks. In fact this reaction is itself a resounding affirmation that capitalism is alive and well.

Our capital markets are clearly alert to the enormous risks that the nation currently faces. Stock prices have been driven sharply downward. To the extent that the market perceives socialism or any other factor to be a genuine threat to economic prosperity, this perception is reflected in current prices.

With respect to the news at hand, and what it might portend for investors, the damage is done. Capital markets are forward-looking and brutally efficient, so investors have already felt the effects of any economic harm that might result from potential government expansion. The impact on the real economy will play out over coming months and years, but security prices have already fallen in anticipation of slower growth. Sellers of stocks have been able to entice buyers only with dramatic reductions in prices that offer above-average expected returns. Going forward, if news proves to be consistent with the current level of pessimism, those returns will be realized by investors who stay the course. If the news is worse, returns will be lower, and if news is better than expected, returns will be higher.

While national growth rates can certainly be inhibited by government expansion, there is no clear link between a country’s growth rates and its stock market returns. Though it may seem intuitively appealing that nations with higher growth rates should allow investors an opportunity to earn abnormal rates of return, empirical evidence casts doubt. A recent study assessed emerging market countries, which are perceived to be less efficient and would therefore have more opportunity for exploiting such a connection. There proved to be no advantage to knowing in advance which countries had the highest rates of GDP growth. Consistent with economic theory, anticipated growth rates are reflected in current prices.

Investors should not allow political opinion, which is so often emotionally charged, to prompt a departure from rational investing. Politicians seek power, and while Democrats and Republicans both spend in order to attain it, they differ in the expenditures they favor. The President and the Congress are clearly seeking greater government control of the economy. But neither can control the consensus view of millions of investors. It is in this, and in the certainty that markets will reflect good news as well as bad, that investors who believe in the spirit of free enterprise should take heart.

Also In This Issue

Risk And Return: Where Are We Today?
What To Do With Your 401(K) When You Leave An Employer
The High-Yield Dow Investment Strategy
Recent Market Statistics
The Dow Jones Industrials Ranked By Yield
Recommended Investment Vehicles