Reality Test
Worry More About Stock Prices Than the Jobless Rate
By Ben Stein
Special to TheStreet.com
11/07/2001 06:33 AM EST
URL: thestreet.com
Now for a few words about the latest economic numbers and the stock market. Let's first take a look at all of the hysteria about the latest unemployment numbers. In September, unemployment went from 4.9% to 5.4%.
Commentators say this is a record percentage increase in a month, and I guess it is. Certainly for the worker unemployed involuntarily, any unemployment is too much. But 5.4% is not particularly high unemployment.
For unemployment to be only 5.4% when there has just been a nerve-shattering bombing of two U.S. cities for the first time ever, when the economy is in a contraction, is not bad.
In fact, it's surprisingly good. Just to give you an idea of historical precedent, I could not find any time since 1950 when the economy was in a contraction that the unemployment rate was as modest as 5.4%. Moreover, in the entire quarter-century between 1971 and 1996, there was only one year, 1989, when average unemployment was as low as 5.4%. And there were some very prosperous years in there.
How Bad Is 5.4%, Anyway?
Again, any involuntary unemployment is too much. But 5.4%, which may be a way station up or down, is not worth getting hysterical about, especially after events that simply destroyed the travel and tourism services sector for a time.
Moreover, the data that show the economy had negative growth of 0.4% in the quarter that just ended are not uniquely grim -- although they certainly are not good. Postwar recessions typically involve a dip of a range of 0.4% at a minimum up to about 2% at a maximum in the past 40 years.
So especially considering the stunning events of Sept. 11, 2001, the economy is reacting surprisingly well, or so it seems to me. It may be that this is just the beginning of a truly horrific drop. But so far, the resilience of the economy outside of the high-tech and travel and leisure sectors has been -- again, it seems to me -- impressive. Of course, the overall picture is uncertain, to put it mildly.
By my reckoning, the decline in the economy -- which has so many pundits in a tizzy -- is cyclical, a more or less typical inventory liquidation recession added to a foreign policy disaster effect, and it will correct itself (I hope). It is not as inexplicable as something else closer to the investor's heart.
P/E's: the Real Horror Show
The "metric" that I do not comprehend is the P/E multiple of the stock market. As I write this, the S&P 500 is trading at an appalling 30 times earnings, approximately. The Dow is trading at roughly 27 times earnings. This is in a time when high-grade corporate bonds are yielding about 6.5%. This means that stocks on an earnings basis are yielding about half of what bonds are yielding, even as we enter a recession and a period of extreme political instability.
There is not one time in the period from 1950 to 1998 when the yield on stocks was as low as it is now. Only in the super bubble year of 1999 were P/E's this high, and we know what happened then. The period I am using for comparison includes times (in the '50s) when the yield on Treasury bonds was in the mid-2% range and the yield on corporates was in the 4%-5% range. If one wants to try to predict stock yields in a time of very low bond yields, there is simply no time when low bond yields would have predicted stock yields as low as they are now or P/E's as high as they are now.
Much of the bewildering growth in P/E's comes from the staggering drop in corporate earnings as the numerator -- stock prices -- inflates or stays stable. Presumably these earnings will rise when the economy turns around. But profits have never dropped as fast in the postwar era as they have from last year to now. When will they rebound to the levels they were a year or two ago?
Historically, it could easily take two years, and maybe more. If profits went to where they were a year ago, and if the Dow and the S&P 500 did not go up at one point, we would have P/E ratios of 20 to 1, still very high by historical measurements, although not uniquely high. But that's only if there is zero increase in the stock market, and P/E ratios of 30:1 are not predicting zero growth.
In a nutshell, I'm asking this: Why is the market so amazingly high? What metric is being used except blind hope, that keeps the market at 30 or 27 times earnings in times of extreme fear and uncertainty?
Maybe someone can tell me, using historical data, where the precedent is. And if there is no precedent, shouldn't we be a bit frightened? Bad things can happen when investors go off the map of the known world. And isn't the word cash a nice word?
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Benjamin J. Stein has been a trial lawyer, a White House speechwriter for former Presidents Nixon and Ford and a campaign speechwriter for Reagan. He has been a columnist for The Wall Street Journal and written for publications including Barron's, New York magazine and Los Angeles magazine. He is a novelist, a nonfiction book writer and a screenwriter, and he has been an expert witness on financial fraud. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. At time of publication, Stein had no positions in the stocks mentioned in this column, although positions can change at any time. While Stein cannot provide investment advice or recommendations, he invites you to send your feedback to Ben Stein. |
