A Rude Awakening (Fred Eason Commentary)

If you plan to retire in the next 10 years, you may be in for a rude awakening. You should ask your financial adviser what assumptions he is using to calculate the end results of your plan. Is he assuming an 8 percent rate of return or maybe as high as 12 percent?

Most research now indicates that a traditional portfolio of equity investments is not going to produce double-digit returns over the next 10 years. The August 2004 Bank Credit Analyst said, “U.S. equity market fundamentals point to average real returns of no more than 2 1/2 percent to 4 1/2 percent a year over the next decade, far below historical levels.” So what is going on here?

Barron’s proclaimed that “2004 Was the Year of Commodities Stocks” in its Dec. 27 online edition. The DiTomasso Group, a commodities research company, noted that commodities were near an all-time low in 1999, just as the stock markets were reaching their peak. The fact is that different asset classes perform differently over long periods of time. The title of BCA Research’s year-end conference for 2004 was “Oil, Inflation and Dollar Instability: A replay of the 1970s?” If you remember the 1970s, you will recall the boom in real assets. For example, oil averaged a 34.7 percent annual return from June 1970 to June 1980. Gold averaged a 31.6 percent annual return and U.S. farmland averaged 14 percent during that period of time, according to “Tomorrow’s Gold” by Marc Faber. Meanwhile, stocks averaged 6.1 percent.

The end of that period brought about the beginning of the great bull market in stocks that brought us double-digit returns through 1999. In the year just ended, the total return on the S&P 500 stock index was 10.7 percent. However, one component – energy – scored a 21.83 percent return. The health care component had a -9.9 percent rate of return. So if your portfolio was loaded with health care stocks, you probably didn’t enjoy a good year. The S&P Midcap 400 index had a 15.59 percent total return in 2004, but the real winners were energy, up 17.92 percent, and materials, up 14.93 percent. If you were in information technology, your return would have been

-20.59 percent. The S&P Smallcap 600 index was up 22.1 percent in 2004. Once again, the energy component was up 31.9 percent and materials were up 16.67 percent. The consumer staple component was down 11.56 percent and the information technology component was down 16.25 percent.

Faber points out in “Tomorrow’s Gold” that the component that leads a “bubble” market to its end never leads the next recovery. So are we heading for a replay of the 1970s? That is a very good possibility. There are some very interesting charts in Maggie Mahar’s recently published book, “Bull,” showing that the long-term trends in hard assets and stocks tend to go in opposite directions. Therefore, hard assets such as oil, gold and other commodities will perform well for long periods of time and when they fall, they tend to be replaced by long periods of outstanding performance by financial assets, such as stocks. Since these are often 10- to 18-year periods, it is important to recognize the cycle in which you are living — and investing. If we are at or near a beginning of a long-term cycle favoring hard assets, does that mean that one should get out of the stock market and buy farmland? As we have seen above, one can invest in sectors of the stock market that will reflect the performance of hard assets. And each of us has different financial goals and liquidity needs.

This is not a call to sell all of your stocks and stampede into commodities. It is a message that the next 10 years may not be anything like the last 10 and that investing by looking in the rear-view mirror is rarely a good idea. If 2004 was the “year of commodities stocks,” it very well may signal a change of leadership that could last longer than you expect. Another good book to read would be Jim Rogers’ “Hot Commodities, How Anyone Can Invest Profitably in the World’s Best Market.” When Warren Buffet is buying silver, stock in Petro China and foreign currency, all investors should take heed.

And some farmland might not be a bad idea, especially if you like walking around on your investment.

(Fred Eason, president of Delta Trust Investments Inc., is a veteran investor in both stocks and farmland.)