- The Washington Times - Sunday, March 18, 2001

After weeks like last week, when stocks collapsed across-the-board, it's all too easy to forget in the emotion of the moment that long-run

stock market stock market investing has proven to be the safest and surest path to wealth creation.

For just a moment, put aside the near-term worries about the Fed's liquidity crunch, declining profits, rising recession probability, the poorly structured tax cut and so forth. Instead, consider this:

Over the past half-century big cap S&P; 500 stocks have generated total returns of 13.4 percent annually between 1947 and 1999, according to Ibbotson Associates. Small-cap stocks averaged 14.4 percent annually. This period includes nine bear markets and nine recessions.Through it all, real gross domestic product (GDP) and corporate profits (national income basis) expanded by a handsome 3.5 percent yearly.

So if in fact we are experiencing the 10th bear market and the 10th recession, investors should not despair (overly).The fog will lift and the sun will shine again. In America, it always does.

Why is this? Because this country has more economic freedom than virtually any other nation in the world. More freedom leads to more entrepreneurship, growth and wealth. And there is no better barometer for the value of business and the outlook for wealth than the stock market.

In particular, there are four major economic freedoms that sustain wealth and growth. Economist Arthur Laffer calls them the four prosperity-inducers or, when freedoms diminish, they become prosperity-killers.

Freedoms from inflation, tax-rate spikes, trade protectionism and government overregulation (including property rights violations) are the key determinants of future growth and wealth.

In terms of prosperity-killers, the stagflationary 1970s were plagued by hyper-inflationary tax bracket creep and Nixonian wage-and-price regulatory controls. The depressionary 1930s were wracked by monetary deflation, exorbitant tax-rates and tall trade barriers.

These were the worst two stock market decades of the 20th century. From 1929 through 1939, large cap stocks declined one-half of 1 percent per year. Between 1969 and 1979, big cap stocks returned 5.9 percent per year.

However, inflation averaged 7.4 percent annually during the 1970s. So real returns were a negative 1.5 percent annually.

Today's outlook is of course much better. Inflation is virtually zero, tax-rates are set to decline (though implementation may be delayed), regulatory burdens are being rolled back (including barriers to energy production) and global free trade will be expanded (especially hemispheric free trade with dollarization). What's more, the end of the Cold War implies continued downsizing of the size and scope of government.

Over the last 20 years, the fraction of GDP absorbed by the federal government has fallen to 18 percent from more than 23 percent. Continued economic expansion combined with even modest budgetary restraint could bring that fraction down to 15 percent over the next decade, according to the Congressional Budget Office. It's a triumph of entrepreneurs over government planners. More economic freedom. More wealth.

Ibbotson Associates' 2000 Yearbook estimates that the Dow Jones Index will reach 100,000 by year's end 2025. This is based on a 10 percent average compounded rate of capital appreciation, in line with actual historical data sets.

Back in 1974 Roger G. Ibbotson and Rex A. Sinquefield forecast that the Dow Jones would reach 10,000 in November 1999. That level was reached on March 29, 1999. It assumed compounded returns of 13 percent annually. So actually their next 25-year outlook of 10 percent growth is rather conservative.

From my calculations, using the S&P; 500's performance between 1982 and 2000, where the annual rate of capital gains was 13.1 percent, it is possible to predict a 4,640 S&P; level by 2010. This is not based on short-term forecasts of the fed funds rate, or second-half GDP growth, or the structure and timing of the tax-cut bill. Nor does it rely on specific GDP projections.

It merely assumes that the rise of economic freedom over the last 20 years, including the technology revolution with all its productivity and growth-enhancing spillovers and applications, will continue into the future. Hence wealth creation, which has temporarily stalled in the past 12 months, will resume at something like the prior rate.

The S&P; is currently around 1,160. So the market looks undervalued. It's a good time for long-run investing. Keep the faith, investors. Faith is the spirit.



Lawrence Kudlow is chief U.S. investment strategist and chief U.S. economist at ING Barings LLC.


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