History Teaches Four Important Lessons about Investing

 

Just look at the long-term chart of the Dow Jones Industrial Average below. The first thing you’ll probably notice is that it starts at the bottom left and rises strongly to the top right of the chart. So the message is clear: U.S. stocks have risen over this period.

And that’s why many pundits keep claiming that stocks always rise in the long term.

Unfortunately this conclusion is not only somewhat naïve; it is even false, because it makes some hidden assumptions about our future.

It is impossible to draw a universal conclusion from a single observation — or even from a myriad of observations. This method is called induction, and logic proves it’s impossible.

So the correct statement should be something less ambitious. It goes like this: “Since the early 1900s, stocks have risen strongly in the U.S.”

And I want to add an important point: There was a very good reason for them to do so.

You see, during that relatively long period the U.S. rose from a very low starting point to the most powerful and wealthy nation the world has ever harbored. It’s actually one of the most amazing success stories of all time.

If there was ever a country whose economic path seemingly went straight up, it has been the U.S. The very country we Europeans used to call the country of endless opportunities.

Growth Miracles Aren’t
Miracles at All

Of course we would all like to extrapolate this impressive trend into the future. But history teaches us that we have to be somewhat cautious in doing so — the next 100 years will not necessarily resemble the past 100 years. If they did, we could expect a similar satisfying outcome for the stock market.

But even if this ambitious assumption turned out to be right, we’d have to allow for major drawbacks on the way up. Drawbacks like the Great Depression and World War II. In the bigger picture they both turned out to be mere bumps in the road. Yet for millions of people living through those times it was much, much more.

But how about the assumption of a continuation of the American success story?

I think there is a very important point to be made, a point of utmost importance to all of us living in the U.S. or in Europe today. The U.S. success story was not just happenstance. Far from it. Growth miracles aren’t miracles at all, never. They are always the logical outcome of capitalism, free market and pro-growth oriented policies.

Unfortunately the U.S. and Europe have strayed away from this concept … even far away recently. Instead of letting the free market take care of our economy and wellbeing, we are on a path to ever more government regulation and intervention.

We have allowed our central banks to become extremely powerful central planning agencies. And we have allowed our governments to run up surreal deficits, mountains of government debts and cockamamie promises.

Therefore we have to be skeptical about the next chapters of the U.S. success story. Without a major shift back to prudent monetary and fiscal policies, which are the cornerstones of free market oriented success stories, there will be no success … but demise.

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History’s Four Valuable Lessons

It’s definitely possible to learn from history. And the history of mankind tells an interesting story of the rise and fall of nations. So there is still hope.

And for you as an investor this is very important …

First, it leads to some humility and humbleness. All of us who have been born into the wealthy and relatively free western societies are blessed without our own doing.

Second, nothing outside the law of nature is for sure and accepted as unchangeable. We were lucky enough to witness the sea of change that freed huge parts of the world from communism and made the world a better place for hundreds of millions of people. Other generations lived in much more demanding times.

The fall of the Berlin Wall in 1989 gave a burst of freedom that led to the collapse of communism in Europe.

Third, it’s your responsibility to take precautions to make sure you will not be swept away by major changes and impositions. Diversification — even geographically — can do a lot to achieve this goal, at least financially.

Fourth, history teaches us that we better keep an open mind. If you think outside the box, will you be flexible enough to cope with major changes unthinkable to a vast majority — and even anticipate them to some degree.

We Are in the Midst of
a Tide Change

Decades of monetary and fiscal mismanagement in the U.S., Europe and Japan are driving the current financial system to a tipping point.

Unfortunately it is unclear how the endgame will turn out. If market forces were allowed to take over, a huge wave of debt deflation and a deflationary depression would likely follow. But if the ubiquitous inflationists were to get their way, the world would be heading to an inflationary crisis.

Both scenarios involve huge losses of wealth and welfare. Both imply severe social and political risks as well. Due to the mechanics of politics in our social welfare democracies I rate the inflationary scenario at a much higher probability than the deflationary one. Therefore I continue to suggest gold as insurance.

You can conveniently buy it as an ETF, like SPDR Gold Shares (symbol GLD). Or you could buy the real thing, that is bullion or coins.

Best wishes,

Claus

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