It's Risky Out There

Tuesday, 19 May 2009 18:50 Written by David Strom

Has the economy turned a corner? Are the “green shoots” just “yellow weeds?” Did the stock market bottom in March or will it reach new lows? Are we facing inflation or deflation? When will housing prices bottom out? Is the commercial real estate market about to implode, and if so what will that mean for our fragile financial system?

If you watch CNBC or Bloomberg you will be bombarded by opinion after opinion on these and other issues, and be given reams of investing advice based upon the particular answers each guest is wedded to.

Surely someone is right, but how to tell? Perhaps more importantly, how much are you willing to bet that your guess about what is to come will turn out to be correct?

And that is the point. Right now too many variables are in flux for anybody to truly know what direction the economy will take in the near and medium term. For a long time we all claimed to know that investing was risky, but few of us truly believed it. And despite the lessons of the past year, it seems that most of us are longing for a return to a normality that we thought existed before the present crisis—a normal where a “risky” investment usually just meant one that provided abnormal returns.

The fact of the matter is that investing is always risky, but the next few years will be particularly so. It is not only the financial system that is fragile, but many parts of the world economy are as well. The current financial crisis has exposed enormous imbalances that existed before the crisis and still persist in the US and world economies, and the readjustments will take a long time to accomplish and be especially painful. In the process the relative stability that we have enjoyed in global politics will be threatened, in turn threatening the economy even more.

Consider just a few facts: entire industries such as the automobiles, newspapers, and retailers are being pummeled and fundamentally reshaped during this recession. Consumer spending patterns will be fundamentally altered, but nobody knows exactly in what way. Government has engaged in unprecedented interventions in the market, the limits of which we still haven’t seen. Don’t even get me started on the unsustainable levels of debt that the government is relying upon for its “stimulus” and “reform” packages. Unemployment will continue to rise into double-digits, and it is unlikely to come down quickly, adding pressure on both consumer spending and the housing market. International trade has plummeted, decimating export-oriented economies such as Japan and Germany. And of course international tensions have been on the rise both independent of the economic crisis and because of it.

For these reasons and many more it seems insane to me to blithely assume that things are getting back to “normal”—meaning the conditions that existed prior to the bursting of the housing bubble. The housing bubble itself was not “normal” and under no circumstances can we turn back the clock to 2007. And even if were somehow possible to do so, it seems extremely unlikely that our policymakers could accomplish this task given all the political constraints that exist.

In short we face several years or more of elevated risk in the economy and the investment environment—years in which it makes no sense to make plans that are based upon an assumption of relative stability and predictability.