Thus the thing to focus on is that the prices of risky financial assets are very low—not as low as they were last March, when the S&P 500 kissed a level of 667, but still very low. Why are they so low? The answer is that the risk tolerance of the private market has collapsed. For example, consider what the University of Chicago’s Nobel Prize-winning economist Bob Lucas told Tom Keene of Bloomberg last March 30—that he was 100% in cash:
LUCAS: [T]here is no question that fear is what this liquidity crisis is. I mean the reason I got into money [with my portfolio] is that I got afraid to leave my pension fund in other securities. So I’m sitting there with a portfolio full of zero-yield stuff just because I’m afraid to do anything else. I think there are millions of people like me.
KEENE: What will be the signal for Robert Lucas to go back into the markets...?
LUCAS: I don’t know. Robert Rubin made a joke about that in the first session today. Nobody knows...
My personal investment strategy for retirement has been (and continues to be) to diversify across a set of passive index funds: some equities, some fixed income, some in the US, some abroad. I do not think I can forecast interest rates, nor can I pick stocks (although I try to pick REITS, mostly for fun, because I do, after all, teach real estate). I know that over my investment horizon (I expect to retire in something like 20 years), stocks and bonds will perform better than cash. I did not change my allocations last year, because, well, once the value of stocks fell, buying new ones seemed cheap. I never take short positions, because when it comes to investment, I am a coward, just not so much of one that I would ever think to put everything in cash (or even worse, gold).
The irony, of course, is that my investment strategy reflects a greater belief in efficient markets than Lucas'. To be fair, though, he is older than I, and so has more about which to be afraid.