Off topic - NYT piece on those DJ 36,000 guys.
September 5, 1999
Imagining the Dow at 36,000
By JONATHAN FUERBRINGER
Is the sky the limit?
The answer from James K. Glassman and Kevin A. Hassett, the authors
of the new book "Dow 36,000," is an unqualified yes. And many investors
may be too ready to agree, with the Dow Jones industrial average seemingly
heading for an unprecedented fifth consecutive year of double-digit returns.
In their analysis of why the stock market's bull run should only get faster,
they sweep aside the naysayers and assert that 36,000 is a perfectly
reasonable level right now for the Dow, which closed on Friday at
11,078.45. And, they say, the rest of the stock market could join it in such a
takeoff. "Stock prices could double, triple, or even quadruple tomorrow and
still not be too high," the two write in excerpts of their book in the current
issue of The Atlantic Monthly.
Their contention raises a question that has troubled market strategists and
investors since the bull market hit high gear in 1995: Is the stock market
overvalued and, if it is, will it fall?
The issue is of immense importance. The valuation of the stock market is a
guidepost on which the market's best strategists depend to decide if stocks
can climb higher. But valuations are hotly debated, and many of the traditional
measures have been dismissed -- rightly -- as flawed during this bull market.
Over the last several years, fear that the market was overvalued led many
analysts to pare back their exposure to stocks. One who did was Charles I.
Clough Jr., Merrill Lynch's chief investment strategist, who just announced
his retirement.
At the same time, Abby Joseph Cohen, the market strategist at Goldman,
Sachs & Company, has employed her own valuation methods to conclude the
opposite -- that stocks are fairly valued and still have room to rise.
Now, though, the Dow Duo -- Glassman is a financial columnist and Hassett
is an economist -- have decided to go boldly where no man has gone before.
Their assertion that the Dow could be beamed up to 36,000 makes another
new book, "Dow 40,000" by David Elias, look downright stick-in-the-mud.
Elias, the president of Elias Asset Management, expects to get to 40,000, but
figures that it will take until 2016. "It will take time, patience, and wise
money management by investors, corporations, and government entities
before the economy and the market can support price levels of that nature,"
he writes.
What is especially provocative is Glassman's and Hassett's view of how to
value the stock market -- and how that affects the outlook for stocks. They
reject the generally held Wall Street belief that the sharp swings that
characterize the stock market make equities more risky. The authors contend
that over the long term, stocks are no more risky than bonds, because the
returns from stocks match or outdo bonds.
Using the research of professor Jeremy J. Siegel of the Wharton School of
the University of Pennsylvania, the Dow Duo point out that over the worst
20-year periods, the inflation-adjusted return for stocks was an increase of 1
percent while the worst for Treasury bonds was a decline of 3.1 percent.
Looking at a wide range of returns over many years, Siegel's data indicate
that the risk of owning a portfolio of stocks falls to that of bonds at around
20 years.
Because investors are willing to pay more for less risk, Glassman and Hassett
say stocks can go much higher than previously assumed before they become
too pricey or overvalued.
Investors, they contend, could be comfortable even if price-to-earnings
ratios, the traditional valuation barometer for the stock market, were now
nearing 100. The P/E ratios for the Dow and the Standard & Poor's
500-stock index are currently around 30, well over the historical average of
14 to 15..
And while they know that the Dow really can't get to 36,000 tout de suite,
they think it will be there pdq. In an interview, Glassman said he and Hassett
saw Dow 36,000 in three to five years, which assumes annual returns even
greater than the unmatched performance of the last four and a half years.
They did not inform their readers of this caution, however, in the Atlantic
excerpts, leaving them to think that warp-speed gains are possible.
Wow! Three to five is still fast. If true, it means that millions of investors
who missed some of the stock bonanza since 1995 still have a chance to
strike it rich.
So what should investors think?
Clearly there is a need to look at stock market valuations in new ways. But
it's not likely that even those who favor some sort of adjustment to the usual
methodologies are as exuberant as Glassman and Hassett.
In a speech late last month, Alan Greenspan, the chairman of the Federal
Reserve, endorsed a new way to account for software investments in
figuring P/E ratios. That change makes the stock market look only slightly
overvalued compared with history, rather than extremely overvalued.
But in the same speech, Greenspan sounded what could be taken as a
warning about assuming that investors will always be focused enough on
long-term returns to believe that stocks are no more risky than bonds, the
key to the "Dow 36,000" theory. "History tells us that sharp reversals in
confidence happen abruptly, most often with little advance notice," the
chairman said. "Panic market reactions are characterized by dramatic shifts in
behavior to minimize short-term losses."
Ms. Cohen of Goldman has adjusted her valuation methods to bring them in
line, in her view, with the way the economy works today. Lower inflation,
she has argued, both improves the quality of corporate earnings and makes
higher valuations less threatening. "You have to make sure the valuation
approach is meaningful," she said.
Although Ms. Cohen has lowered the risk premium for stocks compared with
bonds in her computer model, she has not eliminated it, as Glassman and
Hassett have. And her analysis shows that the stock market is "fairly valued"
now -- not undervalued.
Siegel of the Wharton School applauds the Duo's work but disputes the
conclusions; the authors, he says, assume that all stocks can be given P/E
ratios that should be reserved for Internet stocks.
But leave this debate over P/E ratios of 100 to the experts, who will clearly
disagree; that is what makes a market. There are still good -- if not new --
lessons to learn from "Dow 36,000," published by Times Books.
What Glassman and Hassett tell you -- especially in the rest of the book -- is
that being a long-term investor in stocks is smart, because it reduces the
negative impact of the short-term volatility of the equity market. This is an
argument Siegal has been making since 1994, when the first edition of his
book, "Stocks for the Long Run," came out. Glassman has done the same in
his columns for years.
But the converse is also true -- and that is another lesson not to forget. If an
investor has a shorter-term view, the risk of stocks rises, compared with
bonds. That means that high P/E ratios become a problem much sooner. In
other words, "Dow 36,000" and P/E ratios of 100 are not for short-term
investors.
There are reasons -- even if they are not the ones the book spends the most
time on -- to think that the stock market can go higher. If the Fed can keep
inflation in check and the economy growing, the market can move higher
over time, even if Fed interest-rate increases cause temporary downswings.
But don't bet on the Dow hitting 36,000 soon.
"I worry," Glassman said in an interview, "that people will get carried away
with the notion that the Dow will be 36,000 tomorrow and assume they need
to be in the market only six months to cash in.
"The message of the book," he said, "is be a long-term investor -- and that
the stock market is undervalued, so you can be comfortable being a
long-term investor."
That's a good message. And just the kind of cautionary tone the Atlantic
excerpts needed.
Copyright 1999 The New York Times Company |
