Greenspin Alert: Stocks Are Risky Business (Fool Plate Special) October 15, 1999

An Investment Opinion

Greenspin Alert: Stocks Are Risky Business

By Brian Graney (TMF Panic)
October 15, 1999

With just over two weeks to go until Halloween, the U.S. stock market is up to its old October tricks again. Investors may have casually noticed that the major market averages have been sliding all week, which seems to happen every time the tenth month of the calendar rolls around and pumpkins start appearing on doorsteps.

This morning, the Dow Jones Industrial Average sank again, continuing a five-day stretch during which the over-watched index has lost roughly 5% of its value. Here's a list of today's bad omens:

-- It's October, after all.
-- A key government-monitored inflation gauge, the producer price index, indicated that prices rose in September.
-- The Red Sox are still alive in the baseball playoffs, which is surely a bad sign.

To top it all off, Federal Reserve Board Chairman Alan Greenspan gave a speech last night on the topic of risk. Here's what he did say -- holding real assets, or equity claims on those assets, is risky. Here's what he didn't say -- sell your stocks now.

Instead of plugging the chairman's speech into their word processors and doing a search for the words "bubble," "irrational," or "1929," perhaps the market commentators who busy themselves by keeping tabs on Mr. Greenspan on a day-to-day basis should sit down and actually read last night's speech. Perhaps ordinary Fools should as well, since the meat of the speech deals with an important topic in equity investing that is often overlooked -- the risk premium associated with individual stocks.

For accepting the risk of becoming an owner in a business whose future results are anything but guaranteed, investors in individual stocks will demand a higher rate of return than they can receive from an investment such as a Treasury bond, whose future return is backed by the full faith and credit of the U.S. government. This difference, or spread, is referred to as the equity risk premium. Greenspan suggests that this premium is falling. He doesn't attempt to quantify it; after all, it is not carved in stone somewhere. What he does consider, however, are some theories that could explain why this change in the equity risk premium is taking place.

Besides the eroding effect that widespread real-time financial information has had on information-related risk, the Fed chairman suggests another phenomena may be occurring -- investors are wising to up the benefits of long-term investing in stocks. Of course, he didn't say it quite like that:

"[Some analysts] assert that a long history of a rate of return on equity persistently exceeding the riskless rate of interest is bound to induce a learning-curve response.... According to this argument, much, possibly all, of the decline in equity premiums over the past five years reflects this learning response. It would be a mistake to dismiss such notions out of hand. We have learned to no longer cower at an eclipse of the sun or to run for cover at the sight of a newfangled automobile."

Could the investing public be embracing the well-documented advantages of putting long-term money into equities instead of precious metals, the money market, or government bonds? Are investors becoming, in effect, more Foolish? And can the Red Sox possibly come back and beat the Yankees?

These questions are left for investors to consider on their own. It goes without saying that risk is a part of equity investing and always will be. But it does not need to serve as a limiting factor in investment decisions. As the original, now-collector's-item Motley Fool Investment Primer (circa 1994) said on the issue of whether or not to invest in individual stocks, "The least-mentioned, biggest risk of all is not taking enough risk."

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