Graham and Doddsville -- Value Investing In The New Era Message Board

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Strategies & Market Trends : Graham and Doddsville -- Value Investing In The New Era

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To: porcupine --''''> who wrote (124)	4/2/1998 7:45:00 PM
From: Freedom Fighter	Read Replies (2) of 1722

>I completely agree that the cost of capital and the return on capital >must tend toward equilibrium. But, I also believe that over time the >productivity of both capital and labor increase, due to all the >obvious reasons surrounding advances in technology and education. >Therefore, I believe that this convergence of asset prices and asset >returns will be >at some level determined by the economic, political, social, and >technological conditions of the future, not those of the 1920's, >30's, 40's, etc. Labor Productivity has been increasing for over 2000 years+ and is more related to GDP growth than a permanent increase in profit margins (temporary maybe). There is no doubt that productivity will increase for as far as the eye can see but it is unrelated to profit margins over the long haul. This is also not the first time that returns on capital have reached this level. In general, higher returns attract more investment which reduce returns. In the present case the high returns have nothing to do with anything but extremely low savings rates and outrageous household credit expansion. Both are unsustainable! It is basically an income shift from people to business. It will end when the pie is divided more equally via wage increases, when the customers are broke, or when all the profits are reinvested to take advantage of the high returns and thus reduces them due to overcapacity. It could also end because the purchase of other businesses will become so costly that the returns will be reduced. The high stock prices are the result of a flood of liquidity being supplied by central bankers to prop up all the bad debts around the world, widespread use of highly leveraged derivatives (instead of 90% margin) and a bad case of insanity and delusion. One need only look at the earnings pre-announcements and the large stock rallies of the same companies on the same day to know that this is the twilight zone! Politics and social factors will certainly have an influence but they do not repeal the laws of economics. If can certainly have an influence but that is generally negative. The balance is at a real rate of return that puts PEs way down from here and return on capital down also. Only straight out central bank manipulation and control over virtually all prices can sustain things the way they are for a long time. This is not impossible. The liquidity they are pumping at present is doing a wonderful job of distorting the free market as we speak. As is did in Japan and eventually destroyed it.

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