Might Be of Some Interest...!
Will we be treading water for a long, long time? Bearish analysts think market is going nowhere for a while.
The Boston Sunday Globe, August 19, 2001, by Steven Syre and Charles Stein
It has to get better soon, right?
That's what most investors are thinking as another awful week in the stock market comes to an end. There have been a lot of awful weeks since the stock market began its descent last March. The Nasdaq Composite index is down more than 60 percent since then; the Standard & Poor's 500 index is off more than 20 percent, the definition of a bear market.
But to a small group of market watchers, the past 18 months are just a sample of what is to come, an appetizer that precedes a long miserable dinner. These superbears foresee an extended period - possibly 20 years - in which the broad market averages go no place.
''It is certainly plausible to me that the Dow could be trading at the current level 20 years from now,'' Robert Shiller told an interviewer last year after the market's initial collapse. Shiller, a Yale economics professor and the author of ''Irrational Exuberance,'' is the best known of the superbears. But he is not the only one. Jeremy Grantham, a prominent Boston money manager with the firm Grantham, Mayo, Van Otterloo, was interviewed in Barron's two weeks ago, and laid out a scenario every bit as gloomy as Shiller's. David Tice, portfolio manager of Prudent Bear, a mutual fund, dishes out a regular diet of pessimism on his Web site, PrudentBear.com.
These folks aren't in the mainstream, but they are not kooks either. Not one of them is predicting that a comet will hit the earth or claiming that he has been abducted by aliens. The bears could be wildly offbase (we certainly hope they are), but it is worth spending a minute or two to consider their arguments.
The bearish case rests on a blend of psychology, mathematics, and history. The history lesson begins at the end of the 19th century when stock prices started a powerful run that reached a peak in 1901. According to Shiller, for the next 20 years, the average real return from stocks was -0.2 percent per year.
The market took off again in the 1920s and reached a new peak in 1929. (Raise your hand if you know what happens next.) Over the next 20 years the average real return from stocks was 0.4 percent. The market had another huge move up in the 1960s that climaxed in 1966. In the subsequent 20 years stocks returned 1.9 percent per year.
The bull run that began in 1982 and ended in March 2000 was the greatest in history, with stocks returning an average of 18 percent per year. Jeremy Grantham says it is inconceivable that the aftermath of such an extraordinary climb will be a short downturn. As he put it: ''Great bear markets take their time. In 1929 we started a 17-year bear market, succeeded by a 20-year bull, followed by a 17-year bear market, then an 18-year bull. Now we are going to have a one-year bear market? It doesn't sound symmetrical. It is going to take years.''
The bear case is practically Newtonian: For every action there is an equal and opposite reaction. ''The bust is equal to the boom,'' said David Tice. In fact, the argument is more sophisticated than that. In each of the market's long upward moves the price/earnings ratio of the market rose significantly.
In other words, investors were willing to pay more for a dollar of earnings on the assumption that future earnings would be terrific. The higher the price/earnings ratio, the more optimistic investors are about the future of profits. Young companies and technology companies typically carry higher price/earnings ratios than older, established firms.
In January 2000 the price/ earnings ratio of the entire market hit an all-time high. In a historical graph in Shiller's book, the 2000 peak looks like Mt. Everest, towering over everything that came before it. Shiller pegs the 2000 ratio at 44. (Using different accounting methods, others arrive at a lower figure.)
The bears say the elevated price/earnings ratios at the top are unsustainable, the product of ''irrational exuberance." Grantham's research shows that eventually the ratios have to move back toward their historical norms. For the S&P that norm is about 15. At the moment the market trades at a price/earnings ratio of about 25.
There are two ways a price/ earnings ratio can come down. The stock market can collapse or stock prices can stagnate for a prolonged period, giving earnings a chance to catch up. Grantham is betting on the second scenario. ''We think the 10-year return from this point is negative 50 basis points a year,'' he told Barron's.
Jerry Jordan probably doesn't qualify as a superbear, but he certainly is bearish. For Jordan, president of Hellman Jordan, a local money management firm, investor psychology is critical to his downbeat forecast. ''We created a generation of speculators and then we damaged them severely,'' said Jordan. He thinks investors will gradually lose interest in stocks, removing the cash flow that has been a critical support to high stock prices.
Interestingly, there is one element that is not central to the bearish case for the stock market: a prediction of economic doom. The horrible stock market of the 1930s, of course, coincided with the Great Depression. On the other hand, the poor stock market that lasted from 1966 to 1982 coincided with a period of moderate growth, albeit high inflation.
What could trip up the bears' neat arguments? Quite a lot. Earnings could grow more rapidly than anticipated, driven by new technology and rising productivity. Interest rates could fall, a development that would justify higher price/earnings ratios. Investors could conclude they are willing to pay higher prices for stocks on the theory that stocks are a better long-term investment and less risky than generally perceived. That was the principal thrust of the 1999 book ''Dow 36,000,'' a very bullish book by James Glassman and Kevin Hassett. (The Dow Jones industrial average has basically treaded water since the Glassman book was published two years ago.)
Bold, long-term forecasts have a way of not coming true. The future is hard to see, a lesson investors have learned painfully over the past few years. But if we meet back here again 10 or 15 years from now and the stock market is not significantly higher than it was in 2001, don't say we didn't warn you.
Steven Syre (617-929-2918) and Charles Stein (617-929-2922) can be reached by e-mail at boscap@globe.com.
This story ran on page E1 of the Boston Globe on 8/19/2001. © Copyright 2001 Globe Newspaper Company. |
