Some Thoughts on the Stock Market From my Favorite Financial Economist

by robekulick

This is a link to a an editorial that appeared in the WSJ by my old professor at Princeton, Burton Malkiel on how to invest given the recent turmoil in the financial markets:

Malkiel’s point of view can be summed up in one sentence: stick with the stock market.

Malkiel believes very strongly in a buy-hold investment strategy and also believes that at the very least the lay investor cannot time the market (there are serious doubt about whether most professional investors can do this either, which I’ll discuss another time). So Malkiel’s advice has always been to keep buying whenever you have the opportunity, regardless of where the market is. So why hasn’t the current situation changed his tune?

Here are his thoughts:

“Is it time to sell all your stocks, which are still well above their lows of 2009? I think not. No one can predict what the stock market will do in this and coming weeks. Stocks may continue their decline, but I believe it would be a serious mistake for investors to panic and sell out. There are several reasons for optimism that in the long run we will see higher, not lower, market valuations.

First, I believe that stocks today are cheap. Price/earnings multiples are just over 14 and forward P/E multiples, which use forecasted earnings, have shrunk to less than 12. These multiples are low relative to historical precedent and are especially low when considered in comparison to a 10-year Treasury yield of 2.5%. Dividend yields of 2.5% also compare favorably with 10-year Treasurys. Multiples do not look cheap relative to average 10-year earnings (the so-called Shiller P/E multiples), but today’s earnings are so much higher than average earnings that a 10-year average is not a good estimate of today’s corporate-earning capacity.”


“Moreover, the structure of U.S. corporate earnings increasingly reflects economic activity abroad—including the rapidly growing emerging markets—rather than activity in the U.S. This is why corporate earnings have been growing so rapidly even though U.S. economic growth has been so tepid. For large U.S. multinational corporations, the continued growth in emerging markets will be the most important determinant of the future growth of corporate earnings. For many companies, what happens in China, India and Brazil is more important than the inability of Europe to get its house in order and the paralysis in the U.S. and Japan.”


“A strong dose of modesty is clearly in order. We all need to be aware of the limits of our ability to forecast future stock prices. No one can tell you when the stock market will end its decline, but there are some things that we do know. Investors who have sold out their stocks at times when there have been very large declines in the market have invariably been wrong. We have abundant evidence that the average investor tends to put money into the market at or near the top and tends to sell out during periods of extreme decline and volatility. Over long periods of time, the U.S. equity market has provided generous average annual returns. But the average investor has earned substantially less than the market return, in part from bad timing decisions.

My advice for investors is to stay the course. No one has ever become rich by being a long-term bear on the fortunes of the United States, and I doubt that anyone will do so in the future. This is still the most flexible and innovative economy in the world. Indeed, it is in times like this that investors should consider rebalancing their portfolios. If increases in bond prices and declines in equities have produced an asset allocation that is heavier in fixed income than is appropriate, given your time horizon and tolerance for risk, then sell some bonds and buy stocks. Years from now you will be glad you did.”

So there you have it from Malkiel. No reason to go crazy selling your stocks. Of course, I was already sold on this argument, but I think his points are pretty compelling even if you don’t subscribe to all of his views on investing.