Sun, Feb 16, 2003 page11

• Stocks can beat inflation

  • By Tom Redburn / NY TIMES NEWS SERVICE
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  After watching the stock market grind up their portfolios for three consecutive years, a lot of investors are probably just about ready to give up.

  A little pickup in the markets, enough to recover some losses, and you're ready to stop playing this fool's game forever, right? Conversely, if the market falls further this year, doesn't that prove that there really is no light at the end of the tunnel?

  Maybe you figure you can put your money in something safe, like bonds, and sleep better at night. But for anybody who is saving for the longer term -- for retirement or to help pay for a child's college education -- that could be a big mistake.

  That's because the biggest threat to your wealth is not the risk that the market, which still seems overvalued by almost any measure, will fall further. The greatest risk is that inflation -- even moderate inflation -- could seriously erode your savings and put a huge crimp in your future standard of living.

  That view comes not from one of the perennial cheerleaders for the market, but from David Levine, a former Wall Street economist and investment strategist who was among the first -- in 1998 -- to warn that the stock market was in a bubble that was bound to burst. At that point, Levine urged investors to begin reducing their exposure to the market.

  In 1999, Levine retired from Sanford C. Bernstein & Co, which is perhaps the most respected source of independent research on Wall Street. But he has remained active as a private investor. He recently sent to friends and fellow professionals a long analytical letter, titled "What's the Best Strategy Now?," that provides a framework for thinking about how to invest for an uncertain financial future.

  Levine straddles the long-running debate between the pessimists, like Robert J. Shiller, a Yale economist who believes that the market remains so overvalued that people should stay out of it until it goes a lot lower, and the optimists, like Shiller's longtime friend and intellectual sparring partner, Jeremy J. Siegel, a finance professor at the Wharton School of the University of Pennsylvania, who argues that stocks can be counted on to outperform any other investment over any reasonable period.

  Like Shiller, Levine thinks that the broad market, as measured by the Standard & Poor's 500, is more likely than not to fall from where it is today. He is convinced that the market's performance over the next couple of decades will be far worse than the double-digit returns that stocks have generated, on average, in the past. But, like Siegel, he thinks that because no one is smart enough to time the peaks and troughs of the market, the safest strategy is to stay meaningfully invested in the market all the time.

  Boiled down to its essence, Levine's argument is that "stocks, unlike bonds, are just about guaranteed to protect you against inflation over the long run."

  In contrast to bonds, which pay only a fixed-income stream that is corroded as the general price level rises, a broad portfolio of stocks gives an investor a share in the very businesses that set prices in the economy. To the extent that prices change, so does the revenue of companies in the market.

  While he still considers the stock market overvalued, he argues that it has fallen enough to make it worth investing more in the market. Under almost any reasonable future script for the market, except for a deep deflation (which has happened only once in the last century, during the Depression), stocks can be expected to outperform both conventional bonds and inflation-protected bonds, particularly after taxes. The faster the economy grows and the higher prices move, the better stocks perform relative to bonds.

  Though paradoxical to some, Levine's argument is that investors should see any further decline in the market as an opportunity to start buying more stocks.
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