1929 & 1987: the ominous parallels. (very long)
I thought this might belong on this thread rather than the ASPX one.
Inflation Interest E/B D/B Inflation Interest E/B D/B
1920 15.6 % 6.1% 18.9% 1.87 1988 4.1% 9.7% 21.2% 1.92
1921 (10.9) 6.0 4.5 1.58 1989 4.8 9.3 18.8 2.08
1922 ( 6.2) 5.1 17.7 1.81 1990 5.4 9.3 14.8 2.09
1923 1.8 5.1 14.9 1.72 1991 4.2 8.8 5.5 2.20
1924 0.4 5.0 17.8 1.63 1992 3.0 8.1 2.9 2.86
1925 2.4 4.9 20.0 1.94 1993 3.0 7.2 14.9 3.19
1926 0.9 4.7 15.1 2.03 1994 2.6 8.0 20.0 2.86
1927 (1.9) 4.6 11.2 2.26 1995 2.5 6.8 24.5 3.36
1928 (1.2) 4.5 19.0 2.69 1996 3.3 7.4 26.6? 4.10?
1929 0.0 4.8 21.8 3.41 1997 ??? ??? 27.0? 5.00?
Average: 3.0 5.7 12.1 1.56
Notes: All figures form Value Line. Inflation is CPI growth rate.
Interest is AAA Bond. D/B is DJIA year's average divided by
estimated year's average Dow book value. E/B is Earnings/book
of Dow. My guess for 1996 Dow book is 1400. I'm using a guess for
97 dow book of 1600, and a guess for E/B of 27, or earnings of 432.
I've subtracted "nonrecurring" per share losses from the earnings
figures. Other wise they don't match up well with the book value.
The reason for this is that even if losses are nonrecurring for a
particular company, the same happens to other companies all the
time. Average is for 1920-1991 inclusive, also from Value Line.
Inflation: I think people make too much of the inflation numbers.
Inflation is bad only because it indicates that interest rates are likely
to rise. If inflation were completely predictable, we could adjust for it
completely, and it would not affect stock prices. That is, we would
compute the return on bonds after subtracting inflation, and we
would value earnings in stocks after correcting for inflation. (My
suggestion is to adjust the book value up by the inflation amount for
that part of the book value that was not purchased in the current
year. In this sense, the earnings of a company are understated
during an inflationary period. And the earnings growth rate is
overstated by the inflation amount.) What plays havoc with the
economy is not inflation, but instead, unpredictable prices. Several
examples exist of healthy economies with regular inflation, and many
examples exist of sick economies with no inflation at all.
Over the long run, (i.e. centuries) real interest rates are bounded
above by the human lifetime and the need for most people to work
in order to keep goods being produced. As an example, if real
interest rates were 100% per year, we would all be able to retire
with an income equal to our work earnings simply by saving hard for
a few years. In other words, interest rates are kept low by the fact
that they are put to auction, and we would all like to have that
steady unearned income. In any case, current interest rates are
comparable (after inflation) to those of the 1920s.
The long term average earnings growth rate of the Dow over 76
years has been 4.6% Every now and then good times appear,
and that growth rate increases. For the last 10 years it has averaged
18.7%. After dividing by 3.7% inflation, the growth was 14.5%. Not
bad. After dividing by the usual growth rate this leaves an excess of
9.4%. Now lets review the figures for the 20s. Growth rate of 11.9%.
Inflation was -0.2%, giving an after inflation growth rate of 12.1%.
This was similarly high. Both decades were periods of prosperity in
that inflation became more predicatable. (Note that the current
federal reserve boasts not about how low it keeps the CPI, but
instead about how low it keeps the standard deviation of the
CPI. My favorite is the St. Louis branch: stls.frb.org
But the question when buying and selling stocks is are you getting a
good price. There are two components to a stock's fundamental
value (IMHO). Current book value, and future book value. When
(fundamental) people stocks at high multiples of book, they are
expecting future earnings to bring that book value higher. As the
book value rises, eventually the stock will follow. This works. If you
doubt it, try to find a stock selling for, say, 1/10 of its (real) book
value. Only if the company needs to reduce the accounting value
of a bunch of its assets will it have such a high book. On the
other hand, there is no practical limit to how high a stock can sell
above its book value. Incidentally, the best all date to buy the DJIA
for long term hold was probably its minimum in 1932. At that time, the
Dow got down to 41.2, while its book value was 81.8, for a D/B of
0.50. At that time, it was probably possible to buy stocks in healthy
companies at 1/10 of their book value. But that was a market
bottom. Fundamental investing works, provided you can predict
earnings, and wait long enough for the market to value those
earnings. (Of course both of those can be difficult.)
So no difference between 1929 and 1997 in inflation or interest rates.
The level of productivity in 1929 had been increasing drastically over
that decade far better than it has increased in the 90s.
Mechanization reduced the number of people required to farm in this
country from something like 50% down to 10%. Electricity and better
internal combustion machines improved factory production. The oil
refineries started making cheaper gasoline, while the railroads
converted off of steam. Those were incredibly productive years.
The globalization of the economy was already strong in the 20s.
When the markets crashed in the US in 29, they also wrecked in
Europe and Asia. The depression is alleged to have been caused by
trade barriers, but those trade barriers didn't really go up until after the
stock market crash. In other words, the economy of the 20s was
already global. Of course the government of the 1920s was deficit
concerned, and I believe, ran a surplus for most of that time.
Recently people have been concentrating their investing in the stock
market, but this is not something that you can expect for all time.
Historically, there are a few other choices: gold, coins, real-estate, art,
stamps, collectible cars, foreign securities, base-ball cards, small
businesses, pet rocks, etc. A lot of these are not going to provide
a good return, but thats not the point. Its not what people should do,
its what they actually do. And right now, everybody, but everybody
is investing in stocks. Maybe this could last, but the same thing was
happening in 1929, and a few years later, nobody wanted to admit
they'd ever seen one. In any case, the buy and hold mentality that
has been repeated over and over by the press is neurotic on its face.
What they really mean is "buy, hold a long time, then sell". Someone
who only bought stocks and never sold them would be a stock
collector, not a stock investor. Stocks are perfectly useless until sold
or at least borrowed against. But if borrowed against, you must pay
back or sell eventually. There is simply no useful thing available to do
with a stock certificate except (eventually) sell it. Covered calls
maybe. People are not stupid, and eventually they realize this. At
first they won't sell all their holdings. Instead they'll sell just a few that
have made some really good moves. Then they can tell their friends
about their big profit, and maybe buy a new car, pay down the
mortgage, invest in some real estate, send their kid to a better
school, add an addition to their house, go on a vacation, buy a boat,
etc. All of these things are attractive, and eventually those
stocks with the big gains, given the change in tax laws, will be sold.
After a bull market turns, people expect it to decline for a while, then
level out, and rise again. The vast majority is either too slow on their
feet to get out near the top, or they procastinate doing anything,
thinking "The market always comes back." But human expectations
are largely determined by what has happened recently. When the
price of oil goes up $10 per barrel, they expect it to continue going
up by $10 per barrel. When stocks go up, they expect them to
continue to go up. But no tree grows to the sky, and eventually
stocks turn down. When they do, people are surprised at first,
then they grow to expect them to continue lower. Then they sell their
holdings off with the assumption that they will be able to buy in later,
at a lower price. When too many people come to this same
conclusion at the same time, its called a panic. In other words, the
financial error of people who missed this great bull market can be
abbreviated in one sentence: "Expectations of the return of inflation
that didn't come true." The similar sentence for people stuck in the
coming (this year? next year? who knows?) bear market will be
"Expectations of continual above historical returns that didn't come
true." Eventually continual declines, or even failures to increase
change investor sentiment and they sell. As the price decreases,
sentiment (i.e. expectation) decreases and they sell harder and are
less likely to buy. Voila, bear market.
Eventually fundamental (non-momentum) investors sense the sale,
and they start buying. I am a fundamental investor. That is why I
bought ASPX, as well as AAM, CLFY, and CUBE. It is very very
hard to find really really cheap stocks right now. In a normal market I
would be able to find healthy companies with positive earnings and
prices well below book. All those stocks are gone. With the slightest
hint of a market melt-down (it would have to be about a week of
this past Friday's 3% losses), I am going to cash. I can sit on cash.
Nobody can make me buy a stock. I can wait I have an incredible
amount of patience. I know that history has not ended. I know that
stocks will someday be cheap again, as surely as I know that the
price of anything that is a lot cheaper to make than its selling price
will go down. And hey!, cash has very low volatility, and is very
relaxing to have in your account.
So how much does it cost to make a stock share? Book value, plus
a premium, (say 56%,) for the fact that it is more than just a pile of
assets. This is the level where fundamental players will turn around
a (real) bear market. Note that this fundamental valuation has
nothing to do with growth. The only important growth is future
growth, and we don't know what that is. But competition eventually
kills growth. And competition is brought on by excessive profits.
Among the many things I have done is run an amusement route
with pinball machines. If it was possible to make an easy killing on
those things, I would have bought a lot more and expanded my
business. So would all my competitors. So we grow. Eventually
we have too many machines, so profit declines. Only companies
with the benefit of high barriers to entry can avoid competition.
And most of the market has no such barrier.
There is no question in my mind that the world of today is
immeasurably better than that of 1929. But that has nothing
to do with the price of the stock market. A more important
measurement would be how people feel about their finances.
When they are worried they are less likely to invest in stocks. But
people are natural worriers, what matters is not the real level of
concern, but instead the changes. If humans were not perverse in
this way they would all be incredibly happy nowadays. The vast
majority of the horrible things of the past are past, but people still are
not satisfied. In short, human sentiment is going to continue to go up
an down, and so is the market.
-- Carl |
