GADR: The Long Term Perspective
*Graham and Doddsville Revisited* -- "The Intelligent Investor in
the 21st Century" (9/1/98)
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"The underlying principles of sound investment should not alter
from decade to decade, but the application of these principles
must be adapted to significant changes in the financial
mechanisms and climate." (Benjamin Graham)
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A reader writes:
> ....I guess I'm trying to be immune to all the blood letting.
> There doesn't seem to be much choice but to keep a long term
> perspective and find some confidence in the companies
> fundamentals.
There's an almost unlimited variety of choices, but history shows
that the one you are following is the safest long term choice.
> It would be foolish to sell anything and try to
> time the market, but that seems to be what a lot of people are
> doing.
A few will make great sums by doing so; most will lose by doing
so -- and remain out of the Market, if not forever, then until
it's approaching its next peak.
> Most
> small investors are panicking.
I doubt it; but that's just a hunch.
> This hurts the market even if the
> fundamentals are good. There is more money flowing out of
> mutual funds than there is going in for the first time since
> 1990.
1990 was a great year to go long, and stay long, the Market. At
the time, virtually every "expert" predicted that the coming war
in the Persian Gulf would lead either to another standoff like
World War I or a quagmire like Vietnam. Oil would inevitably
skyrocket, making the global economy a replay of the 1970's.
During the decade of the 1980's, there had been massive
leveraging of corporate balance sheets through LBO's, rising
budget and trade deficits pushing up interest rates, anemic
growth in productivity and return on capital, an S&L bailout that
would supposedly cost 1/2 trillion dollars, the emerging markets
of Latin America had been careening from one disaster to another
throughout the decade, a number of major banks and Wall Street
firms had already gone bankrupt, and, the U.S. had lost the
technology race, and global economic pre-eminence, to Japan.
Further, as the 1990's began, Russia was teetering on the brink
of chaos.
Only the blind could fail to see that the world was headed for
the Great Depression of the 1990's. The buildup in government
debt would leave government without the fiscal and monetary tools
to reflate the economy. And, supposedly, only "sell side" cynics
were advising investors to hang in and buy more.
As it turned out, the Persian Gulf War lasted 4 days, Japan has
spent the decade in the doldrums, emerging markets remain highly
volatile, and Russia continues to teeter on the verge of chaos.
There was a 22% decline in the Dow in late 1990, to a level of
2365, correctly forecasting the coming recession. The recession
lasted 3 quarters and cost President Bush his job, but what was
not particularly deep. Sectors that were heavily leveraged, like
finance, manufacturing and real estate, took the brunt of the
damage, especially in those communities that depended upon the
largess of the military industrial complex. But, much of the
service sector, the largest portion of the U.S. economy,
continued to hum along.
Increased government borrowing to finance the recessionary budget
deficits were no great strain on the financial system. The final
bill on the S&L cleanup appears more on the order of $150
billion, rather than $500 billion. And, U.S. banks generally
have never been more profitable than in the 1990's.
Manufacturing and real estate also rebounded.
> ...A friend called me at home and said he couldn't handle being
> in the stock market anymore....As we were talking he was
> selling his shares at losses online with his computer. I
> couldn't talk him out of it.
There is a certain short term symmetry to Market movements --
both up and down. A slowly rising market can rise a long time
before the last buyer willing to pay a higher price comes along.
The longer the rise continues, the more investors will get pulled
in by rising prices. Likewise, a slowly declining Market can
decline a long time before the last seller is willing to sell at
a lower price. And, the longer the decline lasts, the more
investors will run out of patience and throw in the towel.
Conversely, a skyrocketing Market will more quickly run out of
speculators willing, or able, to buy at higher prices.
Similarly, a plummeting Market will more quickly run against a
wall of long term investors who refuse to sell.
> It is hard to watch your portfolio whither away on paper. You
> tend to think, if only I had taken some profits when it was
> $50,000 up, only to watch it slip to a $90,000 loss.
No matter what the Market does, and no matter what you do, or do
not do, there will always be "if only's". They are very few
billionaires, if any, who don't at times feel "if only" they had
done this, or not done that, they would now have mega-billions.
Imagine how IBM feels about once having sold a 40% interest in
Microsoft and a 10% interest in Intel. Such thinking is rarely
productive, but admittedly, largely unavoidable.
> In my case, this is 20 year money. I have
> to keep reminding myself of this and try to remain unattached
> to the short term fall. It appears that the U.S. economy is
> healthy. Inflation is low. Interest rates have been declining.
> It's the rest of the world that worries me. Is it possible
> for Japan, Russia, and God knows what else to drag the rest of
> us into a long term global depression?
We are in a global slowdown, and U.S. growth has already
been substantially reduced on this account. But, it is very
unlikely to result in more than 2 or 3 quarters of negative
growth in the U.S., if that. Looking out to the early years of
the coming decade, the downturn in East Asia may mean that the
U.S. economy grows by only 2% or 3% per year, rather than 4% or
5%. But, at near full labor force employment, it's unlikely that
the latter growth rate could be sustained without fueling
inflation. Unless, that is, taxes were substantially cut. More
surprising things have happened.
Stephen S. Roach, chief economist and director of global
economics for Morgan Stanley Dean Witter, puts it this way:
"[Global deflation] is highly unlikely today. World gross
domestic product is likely to increase by 2.3 percent in
1998, even with the crises in Asia and Russia. In the
full-blown global recessions of the past, [U.S.] gross
domestic product usually increased only about 1.5 percent a
year. In other words, markets around the world may be
crashing, but the global economy is probably not. That
suggests that the market's reaction to fears of global
depression and deflation are overblown."
See: Message 5639498
There is an analogy to be made between the current global
slowdown and the U.S. recessions of the early 1980's and 1990's.
In the 1980's, the Midwest and the Southwest were particularly
hard hit. The former was at the time called the "Rust Belt",
because so much of its manufacturing base was antiquated.
And, the Southwest's economy was overly dependent upon
assumptions that the price of oil would inevitably rise to $50 a
barrel or more. But, economic conditions in New York and
California, for example, were not nearly as severe.
When the recession of the early 1990's arrived, the situation was
reversed. At that point, the Midwest had a much more efficient
industrial base, and the Southwest had diversified much of its
economic base away from petroenergy. But, a much deeper downturn
occurred in New York and California, where the defense industry
was going into a steep decline, pulling inflated real estate
prices, and bank portfolios leveraged thereon, down with it.
The analogy is that in today's global economy, the regions with
the greatest excesses of credit and manufacturing supply
overhang, and those most dependent upon a single commodity, will
feel the most pain. Conversely, the economy that least fits this
description is the U.S., and therefore it will feel the least
pain.
> If that's the case then
> we've been purchasing overvalued stocks for a long time
Had the Dow been purchased at its peak of 3000 in 1990, and if
tomorrow or the next day the Dow were to fall to 5250, making for
the greatest decline on the Dow of the post World War II period,
the return on paper, assuming reinvestment of dividends, would
still be in the neighborhood of 10% annually -- in line with
historical long term returns. This assumes no stocks were
purchased along the way. The Dow did not break 5250 until 1996.
For the first six years stocks would have been purchased below
that level. Since lower prices mean a greater number of shares
purchased per dollar invested, there would have been a much
greater number of shares purchased below 5250 than above.
> and we will have to
> live with the losses for some time to come.
The best thing that could happen to the disciplined investor who
is dollar-cost-averaging over the next 20 years is for stock
prices to remain depressed for the next 19 years.
> How are you handling all this?
A number of readers wonder why I spend so much time concerned
with macroeconomic issues. The reason is summed up in something
Peter Lynch said.
I heard him make the statement in 1996, a time when the domestic
economy seemed to be heading toward recession, the S&P 500 was
down about 10%, and many hi-tech small caps had been slaughtered.
Concern was so widespread at the time (though it is largely
forgotten now) that Lynch was invited to appear on ABC's Sunday
morning news show with Sam, Cokie and George.
Lynch said he didn't know whether in the short term the Dow would
drop a 1,000 points before it rose a 1,000 points. But, he was
confident it would rise 5,000 points before it fell 5,000 points.
The key was the U.S. economy's long term performance. If one
believes the outlook is good for the macro economy over the
coming 20 years, get in the market and stay in. If not, do the
reverse.
I am firmly in the former camp. Recently, Alan Greenspan
observed that the economy was in the best shape of the 50 years
he has been observing it daily. My view is that the U.S. economy
has never been so well balanced for long term stability.
Over the past 20 years, there has been a global shift away from
statism, militarism, unionism, socialism, welfarism, loose money,
fixed prices, trade barriers, emigration restrictions, and the
like. When the global economy took a tumble in the 1930's,
statism seemed like a fresh idea. Nowadays, the under 40
generation, even in Russia, Cuba, and North Korea, see statism as
a very stale idea.
In the U.S., restructuring used to be a last minute response to
impending calamity. But, in the 1990's, restructuring has
continued throughout the decade. Inventory levels have declined,
and therefore turnover ratios have increased, throughout the
decade. This implies greater return on capital in good times,
and briefer downturns in bad ones.
Notwithstanding the hue and cry over the shift from a
manufacturing based economy to a service based one, and the
decline of unionization in the private workforce, incomes are at
an all time high, and the U.S. is far less dependent on cyclical
industries than most other developed economies.
The monetary and fiscal authorities have greater experience, and
fewer structural impediments, for preventing both the deflation
of the 1930's and the inflation of the 1970's than at any prior
time.
A final thought on long term investing: Harry Helmsley was once
asked how he had acquired one of the U.S.'s largest real estate
empires. He replied that he kept buying real estate, and not
selling it. So, eventually, he owned a lot of real estate. The
same could be said of buying common stock through thick and thin.
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Graham and Doddsville Revisited
Editor: Reynolds Russell, Registered Investment Advisor
web.idirect.com
Web Site Development/Design: ariana <brla@earthlink.net>
Consultants: Axel Gunderson, Wayne Crimi, Bernard F. O'Rourke,
Allen Wolovsky
In addition to editing GADR, Reynolds Russell offers investment
advisory services. His goal is to provide clients with total
returns in excess of those produced by the S&P 500.
His investment strategy applies the principles of Value Investing
established by Benjamin Graham to the circumstances of today's
economy and securities markets.
For further information, reply via e-mail to: gadr@nyct.net
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"There are no sure and easy paths to riches in Wall Street
or anywhere else." (Benjamin Graham)
(C) Reynolds Russell 1998. |
