Smith Faculty Opinion Article

By Dr. John A. Haslem, Professor Emeritus of Finance E-MAIL WEB SITE

The 30 Seconds Outlook
July 15, 2009

The crash following the bubble has and will have brought us de-leveraging, de-globalization, re-regulation and higher taxes with slower growth, increased risk aversion, distrust of conventional investment models, and a focus on “survival.” We have seen higher risk premiums and volatility with lower prices for most asset classes.

Rough estimates suggest that as much as 40% of global wealth has been destroyed. The survival of capitalism and its rewards over the long term now depends on correct anticipation of future global growth and volatility, where the guiding rule must be “buy low-sell high.” There is no longer a “best text book estimate” of future long-term returns.

The financial implications of the crash include future declines in the dollar, much stricter credit standards, smaller equity returns, and increased risk in emerging market securities. All of this requires that personal and professional policy portfolios must be restructured for our new “financial destination,” wherever that lies. We cannot assume that future security risks and returns will approximate historical asset returns and risk. Homes are no longer the keys to our fortune. Pension fund portfolios must be seriously restructured for present and future retirees. None of these necessary changes will be a “slam dunk”—the past good times will not be the future over the next few decades, at least.

An endnote: The government’s approach to “stimulus” has kept deflation at the top of the “wall of worry.” Why? The rate of inflation is highly positively correlated with nominal GDP growth. What do we have? Unemployment is approaching 10%. Current inflation is just over 1%. The personal savings rate has fundamentally increased—less spending due to uncertainty. The GDP growth rate is well below trend. And, then, there is that “nasty fiscal multiplier” which has been assumed by the White House to be quite larger than properly estimated using empirical statistical analysis.

John A. Haslem