The Dollar's Impending Devolution Threatens Long Range Investment Strategies

by: Mark E. Bachmann, CFA

Seeking Alpha Contributor Jake Zamansky recently published an article entitled "Death Of The Buy And Hold Investor" (Seeking Alpha, July 8). It was a interesting piece, although the core idea immediately struck me as wrong. I tried to think back to when I first heard this sentiment expressed, and it was probably sometime in the early 1980's. This was the period during which computer-driven trading was starting to evolve and fears abounded that institutional investors armed with rapid-trade technology would soon have an insurmountable edge in the markets. Such power, many believed, would hopelessly disadvantage individual investors and anyone employing fundamental or "buy-and-hold" investing techniques.

Such concerns were always misplaced, of course, because they relied on the erroneous notion that long-term investors and traders were playing the same game and competing against one another.

In fact, long-term investors had nothing to fear from traders, who could slide in and out of a stock profitably enough for themselves without affecting the long-range prospects of a successful growth company or its committed shareholders. The compounding dividends and regular capital gains from such an investment kept on coming regardless of episodic volatility in the company's share price. There was no wrong time to buy into such a company, and no way to lose money on its stock unless you held on until an accident occurred or its growth prospects were exhausted.

In hindsight, examining their records for the two and a half decades that followed the early 1980's, many long-term investors had a great deal to feel smug about, at least until 2008. With the Dow Jones Industrial Average, as just one measure, increasing more than 1,800 percent from its modern-day nadir in 1982 to its zenith in 2007, investors could have earned spectacular returns from mostly buying and holding a diversified portfolio of fairly average stocks. Many did. Any investor could have done even better if he or she had flashed a little "alpha" and latched onto on a couple of Wal-Marts (NYSE:WMT) or Microsofts (NASDAQ:MSFT) for a while in their glory days, while dodging the Enrons and Worldcoms. Buy-and-hold guys could point with pride to the position of Warren Buffett, their patron saint, so very near the top of the Forbes list of the world's wealthiest people. They could fairly ask of their high-tech stock-churning brethren how many of their cohorts were so exalted.

Buy and hold investors, however, received a shock in 2008, when many of them found themselves giving back a decade's worth of gains in a matter of weeks. While the Fed's frantic resuscitation efforts succeeded in returning a fair amount of this over the next couple of years, something had clearly gone wrong that was not so easily set right again. Investors remained uneasy. The stock market collapse had reflected a disturbing change in our economic fundamentals that no one seemed really to understand but that most people sensed had occurred, like a shift somewhere in the tectonic plates. Artificial stimulus had partially re-inflated everybody's brokerage statements but had done nothing to address the continued ominous grinding of these plates.

While the problem's causes might have remained obscure, its symptoms were everywhere in plain sight. Irresolvable budget crises settled in over the United States, Europe, and Japan simultaneously, attacking all three sides of the foundation to the developed world's post-WWII trilateral economic order. Nowhere in view was any prospect for the sustainable growth that would be needed for painless resolution. Policy-makers faced double-binds everywhere they looked as they battled fiscal imbalance and economic depression at the same time, with the longer-range threat of inflation never out of the picture. National politics became more bitter and dysfunctional than ever.

And this is where we stand at the present moment.

Investors have to understand that what we're in the midst of is no ordinary market cycle, if such a thing ever existed. This almost surely represents the beginning of a fundamental shift in the international monetary order. In trendy contemporary jargon, we are experiencing a paradigm shift, and there is nothing more dangerous at such a time than approaching the new paradigm with concepts tailored to the old one. With the relentless rise of China paralleling the relative decline of the United States, the reserve currency role of the U.S. dollar is an increasingly blatant anachronism. The apparent strength of the dollar at the present time is not real strength but rather a reflection of weakness elsewhere. Erstwhile hopes that the euro would somehow rise to help shoulder some of the reserve currency burden are out the window now as the euro struggles even for its very existence. No one seems to have much of an idea what comes next.

As investors, we don't have to grasp the mechanics of all this - few of us do. What we do have to understand is that predictable long-term investment returns require the kind of stable international monetary regime that we had in the past but that might be gone now from our foreseeable future.

And getting back to Jake Zamansky's article, traditional buy-and-hold investors may indeed, as he says, be "sitting ducks" at the moment. He is wrong, in my opinion, to blame this state of affairs on "high-frequency traders" and "nefarious dark pools", who are simply the conveyers of bad news and not the cause of it. But the thrust of his warning deserves attention.

Monetary instability during the next decade is likely to lead to an environment of serial recessions, possibly interspersed with bouts of virulent inflation as desperate central banks overdo monetary stimulus. Anything can happen in such an environment, and no investment is a sure bet for long. Traditional long-term investors generally lack the experience and instincts to become successful rapid-fire traders. To protect themselves, however, they will need to abandon many of their traditional tools and be prepared to act more rapidly in response to threats affecting their assets.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.