Jeremy Siegel, Ph.D. The Future for Investors

In my last column I predicted that by the middle of this century, India and China will be economic powerhouses that will dominate the world economy and open huge opportunities for investors.

But many believe the world faces unprecedented risks that will stop economic growth in its tracks. Hurricanes Katrina and Rita focused our nation's attention on the risk of a looming oil shortage. There are also frightening threats of nuclear terrorism, worldwide pandemics, and terrorist-induced plagues, among others.

Clearly any of these events would send stock prices plunging. But do these risks mean you should avoid the world stock markets altogether?

I believe that answer is no, and the market's behavior after 9/11 explains why.

No one would deny that the shock of the terrorist attacks temporarily froze our economy. Airline traffic plummeted and the whole travel and convention business caved in. Many forecasters feared the attack would send the economy into a tailspin.

But guess what happened? Instead of flying to their destinations, Americans drove and the auto industry had one of its best quarters in history. While the convention business tanked, hotels reported an upsurge in wedding bookings, engagement parties, and other celebrations marking life's major milestones.

For a time, Americans shifted their priorities and valued family bonds more than business ties. In the quarter following the attacks, GDP actually increased and growth continued the next year despite the bursting of the technology bubble.

It's an old Wall Street adage that an increase in uncertainty sends the market down. That is true. But uncertainty need not cause consumers to stop spending. In fact, after 9/11 the fragility of life convinced many that they should enjoy what they have now, since tomorrow may never come. The U.S. economy showed remarkable resilience in the face of 9/11 and continued threats from the terrorists.

Markets Bounce Back

Facing down risks is nothing new. Americans have always confronted uncertainty and conquered adversity. The scariest time I can remember was during the Cuban Missile Crisis in October 1962. I was a teenager, but realized that both the U.S. and Soviet Union really did possess weapons of mass destruction that could be launched across each other's shores at any moment. Earlier, my parents lived through World War II and my grandparents lived through the Spanish Flu epidemic that killed 40 million immediately following World War I.

But none of these events had lasting negative effects on the markets. Sometimes disasters are really opportunities. For example, stock exchange officials were so petrified at the onset of World War I that the New York Stock Exchange was closed for six months to prevent panic selling. What shortsightedness! Instead of the economy falling, profits soared as the U.S. supplied the Europeans with food and war materials. In fact, 1915 was the single best year in stock market history! Even when the U.S. entered the war, stock prices held up.

Most recently, when Katrina was bearing down on New Orleans, investors first reacted emotionally and sold stocks. Certainly Katrina was going to play havoc with Gulf Coast oil production. Yet investors soon realized that for all the destruction and disruption, the effect would only be temporary.

New Orleans will be rebuilt, insurers will recover, and the casinos that were destroyed on the coast will come back stronger than ever. I never doubted that New Orleans would rise again. Disasters can and will change our patterns of expenditures, but the total amount of spending may go up, not down.

Crises often have a limited impact on the market for good reason. The price of an average stock in today's market is about 20 times yearly earnings. This means that next year's earnings makes up only 1/20, or 5 percent of a stock's value. The remaining 95 percent depends on the profits of the firm beyond the next year. Therefore if a stock's earnings drop for one year by 20 percent, then the price of the stock should move down by only 1percent as long as investors believe earnings will bounce back in the following year. So once the initial shock wears off, prices often recover.

Government Regulation Risk

History also teaches us that the magnitude of the recovery depends on government policy that follows the crisis. It's critical that markets are kept free and the prices are able to adjust to changing patterns of demand. If the government interferes with the working of the market, the situation often worsens.

Such was the case in the 1970s during our first oil price surge. Price controls on gasoline caused widespread shortages and gas lines that snaked miles through city streets. The resulting shortages caused the economy to tank. But when Katrina hit, gasoline prices were allowed to rise and Americans responded by cutting back on driving while they continued to spend on other goods and services.

I am not saying that the rise in energy prices will have no effect on the economy. Providing enough power to fuel our burgeoning economy will be a key to continued economic growth, but it's imperative that the government work with the markets and not regulate against them.

Investment Strategy When Disaster Strikes

Should you wait for a disaster to send the market down before buying stocks? I can't blame an investor for keeping some of his powder dry for buying opportunities that arise out of one-time events. But there are two drawbacks to this strategy. First, by waiting you might miss near-term gains that may be bigger than the subsequent loss. How many people held off buying homes in the last five years, waiting for prices to go down? Furthermore most people don't buy when a crisis strikes. Instead they sell, succumbing to the fear at the time. In short, if there are good reasons to invest, do so now and don't wait for the elusive opportunity to snag a lower price.

Our Biggest Risks

Energy shortages, terrorism, and even global warming are today's risks. But with concerted efforts, these problems will be solved. What I am most alarmed about is far more insidious. I fear that anti-globalization forces will halt the integration of the world economy. World trade is increasingly critical to our economic well-being. Our aging population must rely on the production of goods and services abroad if we are going to avoid a fall in our standard of living.

Closing our borders to immigration, hiding behind protectionist barriers, and restricting the free flow ideas are policies that will cause stagnation and hasten our economic decline.