Ignore the gloom and doom

While touring Europe in the late 1800s, American author and humourist Mark Twain attended several productions of Richard Wagner’s opera, including Parsifal and Tristan and Isolde. He famously declared Wagner a composer whose music is better than it sounds.

Twain’s take on German romantic opera could apply to the current investment climate. There is much doom and gloom out there, from the European debt crisis to the weak U.S. economy and fears of a global recession. Let me assure you — it’s better than it sounds.

No doubt you have read some of the alarming headlines comparing the current U.S. malaise to the Great Depression of the 1930s. This is completely off base and frankly, an insult to the deep sacrifice and pain of the many that suffered through that terrible decade.

Consider some of these stats:

• Between 1929 and 1932, a staggering 5,000 U.S. banks went out of business. Today, corporate America is awash in money and U.S. banks are sitting on about US$2-trillion in cash.
  • U.S. corporate profits plummeted from about US$10-billion in 1929 to about US$1-billion in 1932. In contrast, Wall Street today is in a golden age of profitability. Profit margins have averaged 8.4% for the past 30 years and in 2010 hit a record US$1.68-trillion in the fourth quarter.
  • The U.S. unemployment rate peaked at a staggering 28% in the 1930s. Some cities were economically devastated. In Toledo, Ohio, for example, unemployment peaked at 80%. Today, the U.S. unemployment rate is 9.1%. There are some signs of optimism. Jobless claims are declining and the unemployment rate continues to fall in U.S. cities.

I am not trying to make light of the current U.S. economic downturn. Federal Liberal leader Bob Rae recently described the U.S. economy as “flatter than a pancake,” a colourful assessment that is not far from the truth.

But Wall Street is fine, thank you very much—it’s a political crisis that needs to be fixed. Together, Democrats, Republicans and taxpayers must harness the spirit of American ingenuity and effectively tackle the US$14.7-trillion debt. Decisive action cannot wait until January, 2013 when either President Obama or his successor takes the oath of office.

Meanwhile in Europe, Greece is at the eye of the storm. Its debt-to-GDP level is an eye-popping 149%, it has a coddled civil service and a long and storied tradition of tax revolt. Every day the city of Athens is the scene of violent protests. There is increasing negative sentiment that, sooner or later, Greece will default on its debt.

It’s important to put the Greek crisis in some context. Greece is a tiny nation in the eurozone, contributing only 1.8% to the economic bloc’s annual GDP. Yes, the banks of Europe that hold Greek debt will take a hit if and when the Mediterranean nation defaults, but much of this bad news is already accounted for in the markets.

Widespread fears of contagion across Europe are overdone. In September, Italy passed a sweeping €54 billion austerity plan that will balance the budget in 2013. Growth may slow, but the country has taken necessary measures to stabilize its debt. The economies of Germany, Denmark, Norway and Sweden are strong and poised to lead Europe out of its current crisis.

Salvation is possible for Europe. Consider Ireland, an extraordinary example of how a troubled economy can quickly turn its fortunes around. A year ago, Ireland faced a grave banking crisis, rising inflation and debt downgrades.

The European Union and the International Monetary stepped in, providing nearly US$113-billion in return for cuts to the minimum wage, tax hikes and spending caps. After three years of contraction, the Irish economy is growing again. Labour and rent costs are falling, foreign investment is up and exports growing. Yields on 10-year Irish bonds sunk below 8% in September, making it easier for the nation to finance its debt.

The Irish experience shows us that economic recovery through painful deleveraging is possible. It can be done with a deft mix of political will and public support—sadly, the two key ingredients sorely lacking in Athens and Washington D.C.

Beyond the U.S. and Europe, a very different economic story is playing out in the emerging markets, especially in the fast-developing economies of Asia. Many countries like China, India and Indonesia managed to avoid the recession of 2008-2009. This resiliency speaks to the strong fundamentals driving their economies going forward.

The IMF expects Asia’s new economies to grow at 8% or higher through 2016, a tremendous growth advantage over the rest of the world.

For investors, the good news is markets will recover. I am loath to make predictions, but here is one for the record books: markets in 2012 will be better than the choppy days of 2011. The best investors will stay focused on long-term objectives and be opportunistic in their outlook.

Market sentiment shifted dramatically in the summer of 2011. At the time of writing, major world stock indexes are down between 6% and 12% since late July.

The upside potential for investors is enormous, especially when it comes to global markets. Consider the MSCI EAFE Index, a stock market index that measures the equity market performance of developed markets outside the U.S. and Canada. Despite a volatile 2011, at the time of writing, the index had recovered some 21% in value since the market collapse in March 2009.

Yet the index must climb a further 77% in value to reach its record high in 2007. (In comparison, the S&P/TSX Composite Index must climb a further 28% to reach its 2008 record high.) That’s a huge potential for upside.

The biggest risk for investors is to let their emotions get the better of them. A panic-driven decision to unload your investment portfolio at a moment of weakness in the market can be disastrous to long-term wealth.

And remember Mark Twain’s views on Wagner—it’s better than it sounds.