Today is a great example of why it is so difficult to be an investor. Even when the data says one thing one can easily come up with arguments why this time things are different. On the front page of the USA Today there is a headline: “Bonds outperform stocks over 30 years.”
Historically this type of outperformance has been an anomaly. Whenever a theme like this gets trumpeted in the mainstream media the contrarian impulse points us to go the other direction. This should point towards better returns for stocks versus bonds. Then again…
Mebane Faber at World Beta points out that fifteen years ago in Japan one could have made the very same argument. However recent history shows a multi-decade period of continued bond outperformance in Japan. He writes:
Now, can you imagine having this conversation in 15 years after 15 MORE years of bond outperformance? If you cannot fathom that, then you are not prepared for all of the potential outcomes and how they might affect your portfolio.
The point being is that there are arguments to be made on both sides. One in favor of mean reversion and another pointing towards a structural break in the return generating process. Only in retrospect can we discern which outcome came to pass. However as an investor we need to make these kind of decisions in real-time.
Moving on to another example, i.e. housing, we again have two different people looking at the same data and coming to very different conclusions. In his “how to invest in 2012” piece in WSJ this morning Burton Malkiel writes:
The U.S. housing bust has made the single-family home an extremely attractive investment. House prices have fallen sharply, and 30-year mortgages are available for people with good credit at rates below 4%. Housing affordability has never been better.
On the other hand Edward Glaeser writing at Bloomberg surveys the housing scene and comes to a very different conclusion. He writes:
Housing prices go down as well as up and they always have. You should never buy a house because you’ve been convinced that it is a great investment. In almost half of the Case-Shiller markets, prices didn’t even keep up with inflation over the past two decades. You should buy a house only if you have found a home that gives you the space and neighbors you need to live a good life.
The distinction here may be more philosophical. Whether we should treat housing as an investment or as a consumption decision. In either case some one who has to make a housing decision in 2012 has to deal with the numbers as they stand today. Add to that the fact that housing is one of the big financial decisions we all have to make that is fraught with emotion. A housing decision often affects our lives, for better or worse, for years to come.
The point Meb makes is a good one. The challenge is not in making the absolutely perfect decision. Even given all the data and comprehensive analysis we can never know with certainty what direction the markets may take. What we as investors need to do is invest knowing that the decisions we make can (and will often) be proven wrong. That means building portfolios, and in the case of housing, organizing our lives, so that they are resilient in the face of the inevitable curveballs life throws us.
Items mentioned above:
Are you prepared for another decade of bond outperformance? (World Beta)
How much longer can equities and bonds diverge? (SurlyTrader)
Where to put your money in 2012. (WSJ)
Don’t count on housing to lead the recovery. (Bloomberg)