"My suspicion is that the aggregate of American business
can't be worth more than twice what it would cost to
replace it. That's what it's selling for now. Certainly
individual businesses can be. But all of America?" [See #1323 for complete text of Wayne's comments -- RR]
If the present economic value of all future payments to current labor is zero, and therefore itself not an asset, and if U.S. entrepreneurship, which is among the world's most vital, also has an economic value of zero, then, yes, the market price of all U.S. businesses must converge to the replacement costs of its assets in the long run. Since these replacement costs always fall in the long run (the inverse of the fact that the productivity of assets always rise in the long run) then inflation adjusted stock market prices should have been falling for the past 200 years, instead of rising.
"My guess is that the replacement cost "in aggregate" will be
mean reverting give or take and the "real" return on
equity in relationship to its cost will also (give or take).
[Tobin's thesis -- RR] The latter would indicate that aggregate PEs should also be mean reverting. All of the above; replacement cost,
real return on equity, and PEs have been mean reverting
for about 200 years. It's hard to imagine that this is an
accident and not a meaningful economic relationship."
You have just stated the basic premise of "technical analysis". As Lou Rukeyser has put it (and he should know, surrounded as he is by his 10 technical "elves"): Technical analysis is based upon the belief that cycles repeat. Stated this way, it's kind of circular, since cycles, by definition, are recurring patterns. A more precise definition is that there are certain relationships which recur with a regularity sufficient to profit therefrom. [By this definition, Contrarianism is a technical approach, unless supplemented by a fundamental analysis of why a security is "out-of-favor".]
[There are at least two other I know of:
1. Dr. Will Elder (formerly a physician, now a full time trader and author on the subject) defines technical investing as a form of social psychology in which charts are used as a kind of ink blot test to see when Mr. Market's moods will swing from Bullish to Bearish, and vice versa.
2. The other is one I heard from a technical investor and advisor. I asked him how techies could ignore the fundamental laws of supply and demand. He responded that they don't. But, the supply and demand relationship they study is that for the security itself. I have forgotten his name, but I have not forgotten his point.
Fast forward 15 years. If I recall correctly from reading his memoirs, Confessions of a Stock Broker, Laszlo Birinyi originally analyzed the prospects of companies by calling their suppliers to find out if the company under study was accelerating its orders for new supplies. If so, he surmised that the company's prospects were improving. This, imo, is a fundamental approach.
At some point since then, Birinyi began studying fund flows for a company's stock. This strikes me as a logically analogous approach, except that he now seeks to ascertain changes in the demand for the company's stock.
Is this an approach that finds wider discrepancies between a company's market price and its underlying economic value than methods that, though more direct, are likewise potentially more overworked. I don't know. But, I do know that the longer Birinyi's methods are successful, the more likely it is that he is actually measuring discrepancies between price and underlying value, however indirectly.]
Returning to definition #1, I know of no fundamental economic law that states that the profit margins, ROE, etc. that prevailed in the 1820's, 1890's, 1930's, and so on, are causally connected to what they will be in the present or the future. This would be analogous to "action at a distance" (in time). Imo, it is purely a matter of technical speculation as to whether the average of these relationships will "repeat" (i.e., converge to a mean). Perhaps there will be certain points in the future, when by the selective use of starting and stopping points (one of the problems with all backtesting), such convergence can be "demonstrated" in an academic journal. But, that's
the kind of thing that's been done with sun spots, rainfall in Stockholm, hemlines, etc.
Further, I believe the problem of timing this convergence remains unaddressed. I think your point that timing is not what matters, its risk avoidance that matters, is a good one. But, as far as what to do now and going forward, the state of my ignorance is such that, even if I were convinced these relationships somehow must repeat themselves, I am not willing to allocate capital on that basis without some reason to be confident that the intervening opportunity costs will be overcome. |
