" Here's my question - if the cost of capital in the bond market is already much lower than that of the stock market, why don't companies use debt exclusively instead of equity?"
Who said that bond money is cheaper than stock money? It is not - it is the exact opposite. Why would an internet company want to borrow at a junk bond rate, which would reflect its lack of any prospect of profitability for years to come, when it can do an IPO at 500 times hoped for earnings 5 years hence? The bond money might cost 12%, the stock market money costs almost nothing - you say you want it, and people throw it at you. Yes, I know that finance texts such as Modigliani argue that the cost of equity in such situations is really high because your investors expect so much out of you, but that is total nonsense. If you have a plausible appearing internet business plan, the cost of equity these days is zero. There is your answer.
As to why the market has done so well over since the 1973-4 bear market, take all that stuff about converging risk premiums and toss it in the toilet where it belongs. Theories from university finance departments are internally consistent constructs that bear no more relation to the real world than does Marxism, which is also logical and internally consistent, but totally wrong.
We started out at the end of 1974 with stocks as deeply depressed as in 1932. I suggest you get a hold of a Barron's (perhaps on microfiche at a decent library?) from then, and look down the P/E column; it was the rare stock whose P/E was greater than 4 or selling above book value. There were almost no stocks on the ASE or NASDAQ that were in double digits.
In the subsequent 25 years a lot of things have gone right with the world and the economy, and stocks have deservedly gone up. But beyond that, the market has benefited from human nature - we can read all the history that we want, but our understanding of things is based mostly on our own experience. If the stock market has gone up for your entire life, then it is natural to assume that it always goes up. The more it goes up, the more people want to get on board, so the more it goes up, etc.
I remember in the late 1980's people speculating in real estate telling me that it is impossible to lose money in real estate, because it always went up. That was their experience, and it remained true until it was not true and they lost all their money. More to the point, it was that belief being widespread that created the conditions (excessive prices relative to properties' underlying income generating abilities) that made it no longer true. With today's stock market priced for perfection and nearly everyone close to 100% in equities, any random disappointment or unexpected bad development could cause a downward spiral, both in the market itself, and in terms of its connection to the economy, which I discussed in previous posts.
"Have you thought of contacting G&H directly at their web site?"
The attention given to G&H's book is terrific evidence of a market top, which will surely be noted some day, just as the popularity of Dr. Ravi Batra's "The Great Depression of 1990" after the 1987 crash was a good sign that the market was OK. Why in the world would I want to contact a symptom? |
