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This is a summation of macro factors that I think could impact the stock market for the next 5-10 years. From time to time I'll update the list. While I wish my crystal ball was still working to provide 100% assurance, it does seem to me that the factors that gave us this 20 year mother of all bull markets are beginning to evaporate, as in the recent bubble. The potential being that many of the gains accumulated during this time could also evaporate. Markets as do stocks, have a tendency to retrace gains. Those that got on this market train in the 80s and early 90s have made LOTS of money. Of course those that gone on onboard late (as in the last several years) unfortunately are flat or have probably lost. Is my rationale reasonable or flawed? Thanks. -Boomer Demographics -Retirees Need Income -Hunt for Yield -Boomers Will Buy Less -Market Valuations -Market Cycles -Reduced Risk Appetite -Increased External Risk -Pension Fund Non-Performance (Liability) -Accounting Standard Revisions -Aggressive Management of Earnings -Gold - A New Asset Class -The Bubble -Positives For Tech Stocks -Positive for Economy Read on if interested in my rationale: 1/ Demographics: Baby Boomers are aging. Historically increasing age correlates with increasing financial conservatism. The boomers drove this market up and will drive it down. The leading edge boomers are beginning to retire now. 2/ Need for Income: Retired boomers will first start looking for stocks with dividends and not growth. Then they will look for more fixed income returns such as CDs and bonds. There will be a secular trend to reallocate out of the equities market. It will weigh heavily on stock prices. At first stock prices will just stagnate and then subsequently fall as non-performance will force investors to look elsewhere. Rallies will occur from short term over sold conditions but think it will inevitably be a series of lower highs and lower lows. 3/ Hunt for Yield: Although treasury bond yields are historically low at about 5.4% for 30 yr bonds they could go lower due to demand for safety and returns. There may come a time when a 5.4% guaranteed yield would be considered very desirable. Inflation protected treasuries may offer the best overall protection. If rates do climb later this year during what will probably be a modest economic recovery that may be a good buying opportunity for treasuries. 4/ Baby Boomers Will Be Buying Less: Aging boomers will be buying less of everything except healthcare. As people age they aren't as concerned with having the latest and greatest. Look around at how many in their 50s, 60s, 70s, 80s, 90s are really concerned with having a new car or the latest style or the greatest toy. Boomers are still trying to relive their youth through collectibles and the toys of their youth. Accumulation occurs in the 20s, 30s, 40s, 50s and declines each decade. Older boomers would be looking for experiences like travel if not for 9-11-02. 5/ Market Valuations: While the economy will probably improve on a cyclical basis this year the earnings will not support the valuations (PE levels) that have been artificially pushed up much beyond long term averages by the massive equity investments of boomers during the late 80s and 90s. In other words a 10-15% earnings growth will not support a 25 PE once the reality hits that the 10-15% growth is as good as it gets. Overall enthusiasm for stocks is waning and overall PEs will fall and probably overcompensate on the down side. And to top it off, tighter accounting regulations will, as a fallout from Enron, probably negatively impact stated earnings (see below) 6/ Market Cycles: Longest economic expansion in history is now history along with the longest bull market. The economy and markets are cyclical and averages always regress to the mean. We've got a long way to go to get stock market returns back down to the long term average. The logical conclusion is we could have 10 years or so of flat returns or maybe very negative returns for a lesser time. 7/ Investor Confidence: There is a reduction in overall investor confidence. Accounting irregularities such as Enron's are probably only the tip of the iceberg. Financial publications in recent years have been carrying articles about funny earnings and potential financial indiscretions at many firms. If investors start to lose confidence in the financial reports of public companies the exit doors of the stock market will not be wide enough to let the stampede out. 8/ Reduced Risk Appetite: Reduced appetite for risk as a result of Enron and others will reduce the availability of all capital (including venture) and will slow expansion. 9/ Increased External Risk: The market discovered the perils of external risk on 9-11-02. These unforeseen events (terrorism, war, major natural disasters, etc) are unfortunately, to some extent, more probable. They must be factored in as the result can be devastating. This is something airline stocks have always faced. This risk factor is just another overhang to the market. 10/ Pension Fund Non-Performance: Non-performance of defined benefit pension funds of large corporations will be a double edged sword. During the 90s most fully funded pension funds actually generated excess returns which were in many cases used as operating income. This income served to further inflate stock prices. In addition it eliminated the need for funding of the plan by the corporation. Non performance of these funds will be a double whammy as it reduces operating income and increases expenses. ncpa.org 11/ Accounting Revisions: Aggressive accounting used by many firms to keep stock prices up and their options in the money (so executives can make a quick profit) will come under further scrutiny. The risk reward on this tactic will change so that company stock will be punished severely for anything less than conservative accounting. Furthermore there will be pressure to change accounting standards so that the employee stock options are covered on the balance sheet. Under present accounting rules, stock options are not treated as a cost to the firm that issues them and do not appear in the income statement. But they are not free to the company. This change in primary compensation to options in the late 1990s artificially inflated the earnings of high tech firms. nationalpost.com 12/ Aggressive Management of Corporate Earnings: A subset of the accounting standard revisions is the way corporations have been "managing earnings" with a focus purely to push the stock prices to the upper boundaries using pro forma, corporate restructurings, aggressive accounting, etc.. While it may work in a bull market when investor confidence is strong, it can cause an implosion in the opposite scenario much as a rubber band that is stretched too far. 13/ Gold Stocks - A New Asset Class: I think there is a case to be made for gold stocks both as insurance and a potentially good investment. Gold has been out of favor for over a generation. Yet it was one of the best performers in 2001. It is not taken seriously by any financial analyst of note and is in fact down played by most. They scoff at it. Gold production is a tight market as there are not that many mining companies. If demand starts to pick up and gold prices climb, the return on these stocks will make the internets look tame. One of the major problems that has depressed gold prices in the 90s has been the forward selling of gold by most major gold companies. They sell what's in the ground before they get it out. There is now consolidation between companies that have gone on record that this hedging will stop. While hedging helped earnings while gold was falling, ending the policy will put a floor under the POG (price of gold). Gold to some extent is correlated to inflation, and political or financial instability, although more so in the past. If the economy recovers then there could be inflationary pressures. If the Middle East blows up or other instability develops, gold could come into further demand. If the economy slows further and stocks get hit harder, gold may become a safe haven. If the dollar weakens due to increased government spending it will cause the POG to rise as it is dollar denominated. The downside to gold prices $280/oz at this time seems limited. One big overhang that has depressed gold mining stock prices in the mid-late 90s, was the Bre-X gold scandal (the Enron of gold stocks), although penny gold stocks have always had a touch of scandal associated with them. This is now ancient history for many investors. I think the biggest drawing card for gold stocks (as a contrarian) is the fact that gold has been out of favor for so long and is for large numbers of investors an undiscovered asset class. Remember when Cisco at 80 was a must own by every analyst. Unfortunately there were no more buyers left that didn't already own it. There are lots of potential buyers out there for gold stocks. I'd never go overboard with it but would think that 5% (or up to10%) of portfolio would provide some level of diversification and nice insurance. 14/ The Bubble: Technology factors that drove the market to irrational exuberance in 1999-2000 are history. It hindsight it is clear but should have been obvious at the time that technical and financial developments that reached a perfect storm about the time of the new millennium was as good as it gets (for some time). It will probably be a decade or longer before earnings will justify a NASDAQ 5000. The factors were: a. Personal computer market sales matured and growth peaked about late 1999. The windows operating system was maturing which diminished the need to get the latest version and constant PC upgrades to support it. Almost everyone that wants a PC now has one. b. Maturing of PC growth will slow growth of the internet and its associated infrastructure. PCs are the driver of the internet just as the number of cars is a driver for highways. c. Over-optimism for internet growth sparked over-building of computing, bandwidth and storage by carriers and hosting companies. Capital which was readily available for these speculative companies in the 90s is no longer out there. d. Cell phone growth rates have peaked in the US and Europe. Most everyone that wants one has a cell phone (or almost). That wasn't the case in 1995 here in the US or abroad e. The federal reserve pumped massive amounts of money into the economy to compensate for YTK risk. This only expanded an already inflated bubble. 15/ A Positive for the Tech Stocks: There are of course technology developments on the horizon which will stimulate tech demand at some point: a. Generation 3 cell phones with internet access and other enhanced wireless features. b. HDTV will at some point cause a massive replacement of existing analog TVs, broadcasting equipment and cable hardware, etc. c. Implementation of more broad band internet access by phone and cable companies will use up existing backbone internet bandwidth. d. Internet will merge with TV as an entertainment medium as broadband becomes more widely implemented. e. Voice over IP (packet voice) will at some point be implemented by the Bells and major carriers so they can consolidate their Voice and IP networks. f. Need for growth of technology in so-called third world countries. 16/ A Positive for Economy: There will be tremendous wealth transferred from the ultra conservative depression era generation to the boomers. As with most windfalls this will be treated as easy come easy go and will be a significant boost to the economy. Boomers will spend a fair amount of this windfall, and the rest will be saved for retirement and for a legacy for their kids who will promptly spend it. | ||||||||||||
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