What have we learned?
Like everyone else, I’ve been reading (well, skimming) reams of year-end—and in some places, “decade-end”—economic summaries. There’s lots of talk about black swans, financial “Frankensteins,” lost decades, and fundamental changes in investor behavior.
Black swans are old news, and I’ve written on financial innovation and lost decades previously. And I’ve only got a tiny bit to say about investor behavior. I’ll get to that after sharing a few other observations I wish got more attention in all this year-in-reviewing.
1. Faith and patience
It strikes me that way too many people were surprised by the fact that financial markets and the modern economy are very much built on faith and patience, and that loss of either (or both!) leads to chaos. Almost everything you need to know about the fundamental fragility of a modern economy can be learned by watching the bank-run scene in “It’s a Wonderful Life” or by reading a snippet of Keynes:
“Of the maxims of orthodox finance, none, surely, is more anti-social than the fetish of liquidity, the doctrine that it is a positive virtue on the part of investment institutions to concentrate their resources upon the holding of ‘liquid’ securities. It forgets that there is no such thing as liquidity of investment for the community as a whole.”
Perhaps the biggest financial challenge we will continue to face is how to deal with ever-increasing flexibility and instantaneousness in the financial system while there remain tremendous inflexibilities in the actual economy.
2. A triumph of policymaking
The success of central banks in halting a worldwide financial panic that was clearly and dangerously feeding upon itself was remarkable, and I think it’s what will be remembered longest about the most recent crisis. The key remaining question is how quickly the monetary authorities will be able to react when the private banking system starts creating money again in a significant way.
If the Fed and other central banks pull off this balancing act (and I believe they can), the events of the last few years are likely to be remembered years from now as a triumph, rather than as a failure, of economic/financial policymaking. Nothing policymakers can do is ever going to vanquish greed, arrogance, fear, fraud, or speculative bubbles and crashes. Knowing that we have effective policy tools to help get through very serious instances of such crashes without suffering Depression-like consequences would mean vast improvement in all our lives (though obviously there will still be plenty of pain).
3. Investor consistency
Things change glacially, even in the face of what seem like “watershed” events. For example, there has been some discussion of whether individual investors will “return to the stock market.” Research that Steve Utkus and I have done surveying investors earlier this year suggests that most investors never left.
And in terms of a dramatic shift in investing patterns, I’ll refer to the data in the chart below, which show net new cash flows to stock mutual funds plotted alongside total returns for the S&P 500 Index, both on a rolling, most-recent-twelve-months basis.
The S&P 500 Index and net new cash flows to equity mutual funds
December 1984-November 2009
Notes: Vanguard calculations based on mutual fund flow and historical total net asset data from the Investment Company Institute (as of 12/31/2009). S&P 500 total return is as recorded by Vanguard. Net new cash for equity mutual funds is the sum of net new cash flow to equity funds over the trailing 12 months divided by the average of total net assets at the end of each of those months.
I look at this and see no break in the pattern through November of this year. These two series are very much related, especially after about 1994, and while the recent market collapse was huge, recent flows appear to be in line with the observed relationship. If the markets turn in continued good performance, my guess would be the cash is likely to follow.
4. A note of thanks
Finally, at the end of what most are calling, if nothing else, a disappointing decade, it seems to me that a little thankfulness and humility are in order. Things could have turned out very differently.
My grandparents suffered through a ten-year period that included a total economic and political collapse, chaos, war, and personal hardship and tragedy that I can’t pretend to imagine, and somehow survived. I count my family incredibly lucky to come out of this decade in basically good shape, and myself fortunate to be able to do work that I love with friends and colleagues that I respect, for a sound enterprise that we all strongly believe in and to which we’re devoted. So, rather than disdainfully looking back, I’ll look forward to face the new year and the upcoming “teens” with great hope—and only a little trepidation.
Happy New Year!
The core question that you are dancing around is whether Efficient Market Hypothesis is valid. It is the sole reason for Vanguard’s existence regardless of how many fund classes you breed. The next most important question is if there is a viable alternative such as Behavioral and if it can be used for investment management.
I think you guys need to bring John Bogle back and have him explain all of this to you. I suspect he wouldn’t be wasting much time on deterministic activities like charts that try to predict fund inflows.
Also, if I hear that Vanguard is doing anything like trying to buy iShares to increase market penetration I will be GONE. Stick to indexing. If you find it boring, trade on your own account.
A good article, but I’m not convinced by your second point on the triumph of policy making. Haven’t governments essentially borrowed from the future to patch the present? Seems that pain will need to materialize somehow, though perhaps it will be less painful over a longer timeline. The danger seems to be that that will serve as a sign that we have this figured out and can continue spending. The Buttonwood article in the most recent issue of The Economist has an article that I liked on this.
Who in central banks are responsible for doing the balancing act? The fat cat banking CEOs? If they are responsible for doing such fine work their sky high bonuses may be somewhat justified. If not, we are wondering how they justify their income and why they are not being managed.
Yes, the Central Banks “saved” us but we were all harmed. Significantly, and someone should be held accountable.
It will haunt politicians and banks that the financiers that did this are going unpunished.
Being thankful is not inconsistent with being unforgiving.
Very, very well written article!!
Frankly, I don’t understand anything you said and your graphic is just a blur. If there is any correlation between the curves they are purely subjective.
So we avoided a depression. Something to be thankful for. But can we avoid run-away inflation? I don’t see how policy makers will pull that off. And, judging by the cash positions of some Vanguard bond funds, I think your fund managers are also expecting some serious increases in interest rates to fight inflation.
“The success of central banks in halting a worldwide financial panic that was clearly and dangerously feeding upon itself was remarkable” That statement makes no sense to me as it was the Central Banks easing of credit that helped create the bubble in the first place.
What I learned is that CEOs and corporate managers tend to act in their own selfish interests – not in the interests of the shareholders. What I learned is that the Boards of Directors we expect to govern and control the worst inclinations of these corporate managers are themselves either quiescent or colluding in the pilfering of the corporate piggy bank – again at the expense of the shareholders who are the true owners of the corporation.
For the first time since statistics were kept, “mutual” ownership (by pensions, unions and mutual fund companies like Vanguard) accounts for almost 50% of all shares outstanding in the S&P 500. It’s time we start acting like the owners we are. The Vanguard Group is in a position to do this for us, the common shareholder. Vanguard has the voting clout to purge “lapdog” directors and to lobby for independent, tough minded individuals who will look out for the owners – not the executive managers. Why haven’t they? They have the power to monitor the compensation and bonus committees so they serve our interests. Why haven’t they? I truly would like to know.
I’m not suggesting that Vanguard or any other mutual fund begin to micromanage the corporations in which it holds shares. Rather, they need to speak for the owners/shareholders in favor of solid long term planning and sustainable growth and against the quick buck philosophy which seems to be driving so many corporate decisions these days. So why haven’t they?
Perhaps a novel idea on Wall Street, but the idea we may sink into a depression seems to skirt the fact that we are in a depression. There are whole neighborhoods, strip malls, and office buildings empty. Unemployment is atrocious, anybody who does rudimentary investigation knowing the official numbers neglect the chronically unemployed and outsourced, for years running now. We have experienced a banking collapsed, papered over, and the “fat finger” of May 6 was, well, a fat one. If you believe that economic fundamentals on Main Street and history come home to roost, despite all happy talk, the markets have been in lala land. Let investors take a hard look at peril, in these days of minimal moral hazard, amongst debt-ridden corporations, and perhaps there’s much wisdom in not throwing out the notion of lost decades, for a pair of rose colored glasses.