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The most profitable bad news ever

The US is still sunk in its sub-prime mess, Europe is a set of dominos, and only a couple (Ireland and Greece) have fallen, with many left to go - Portugal, Spain and, maybe many more including France.

Closer to home, China might be about to stall and Japan has a seemingly intractable growth problem - as in, the lack of it.

If that wasn’t enough, here in Australia retailers are struggling, housing starts are soft, the dollar is punishing our exporters (and those competing with cheap imports) and interest rates are too high.

The icing on the cake was that we got headlines earlier this week reminding us how many billion dollars were wiped off the ASX after a Friday night fall on Wall Street.

Is it really that grim?

When that’s the message, it’s tempting just to sell up and hide.


Humans can be a terribly pessimistic species when we set our minds to it. Ever on the outlook for danger (thanks to an evolutionary experience that taught us to be vigilant for predators), we’re ready to jump at shadows.

Even though crime rates are falling, you wouldn’t know it - we overemphasise the negative, even in the face of overwhelming evidence to the contrary (for the record, Australian Institute of Criminology figures show per capita crime rates in every category falling over the last decade, except assault, which has remained steady).

So it can be with investing. Ask people about the stock market, and you’re likely to get answers ranging from volatile, risky, dangerous to mentions of the great depression, 1987 stock market crash, tech crash or - more recently - the tough years of 2008 and 2009.

The problem - again - is that while the market can be those things for the unwary or misinformed, and those events did in fact happen, the far more accurate answers should be centred on wealth, independence and opportunity.

Looking through the gloom

The stock market has grown, on average, between 10% and 11% per year (including dividends), since the turn of the last century. It’s a return that, to my knowledge, is unmatched by any other asset class. Yes, it’s an average, and yes, it can be volatile. It’s no place for money you need in the next 3 - 5 years.

But for building real wealth, investing in shares is hard to beat.

Turning our attention back to the list of woes at the top of this article for a second, you might be wondering why anyone in their right mind would invest in shares - or anything - in such a difficult environment. It’s a fair question.

To answer it, here are some things you may not know.

The real news

As at the end of last week, 20 companies in the Dow Jones Industrial Average had reported earnings. Not one had missed analyst estimates.

The chairman of Goldman Sachs Asset Management recently put Greece into perspective. He reminded us that “China creates the equivalent of a new Greece every four months”.

It’s true that the issue is rarely Greece itself, but what would happen to the interconnected global economy should Greece fail, but neither Greece nor the EU has shown any real likelihood of that happening. Even if it did, the recapitalisation of the world’s banks continues at pace.

China’s growth ‘problem’ is a problem we’d all like to have. When talk turns to a China slowdown, the
discussion centres around growth falling a couple of percentage points to ‘only’ 7% or so.

If worst comes to worst

More significantly, even if the worst case does eventuate, the stock market has always bounced back.

Consider the past 110 years or so. The average return mentioned earlier of 10% - 11% is the average return even after including all of those economic and market shocks I mentioned.

That bears repeating. Despite the great depression, wars, oil shocks, bouts of inflation, numerous recessions and regular bouts of market pessimism, $100 invested in 1901 and compounded at 10% (let’s be conservative) would be worth $3.57m today.

Sure, but…

Yes, $100 was worth much more then. The fact remains that the 110 years at 10% would give you 36,000 times your money in pre-inflation returns.

Yes, inflation will eat at your returns - but inflation will happen whether you’re invested or not, so you might as well invest in the highest average return you can find, to maximise those after-inflation dollars.

Foolish take-away

By the time better days arrive and all of the scary news has gone, the share prices will have already risen. As Warren Buffett is fond of saying, “you pay a very high price… for a cheery consensus”.

Achieving the average return over time has required nothing more than buying a representative sample of shares and simply waiting. Buying good companies when pessimism abounds can deliver market-beating returns – and improve on that average.

Are you looking for attractive dividend stock ideas? BusinessDay readers can click here to request a new free report titled Secure Your Future with 3 Rock-Solid Dividend Stocks.
Scott Phillips is an investment analyst at The Motley Fool. You can follow him on Twitter @TMFGilla. The Motley Fool's purpose is to educate, amuse and enrich investors. This article contains general investment advice only (under AFSL 400691).