BUT FIRST A QUICK POLITICAL NOTE:
Being a DNC officer, I am neutral in Democratic primaries, and thus wish both Janet Reno and Bill McBride – and the very impressive Daryl Jones, for that matter – all the best in tomorrow’s Florida gubernatorial race. But it was with a real sinking feeling that I caught one of those stereotypical negative TV ads ripping Bill McBride to shreds, making him out to be dishonest and all the rest, which, from all I have heard about McBride, is just terribly unfair. (Much the same sort of stuff that was done so effectively to assassinate Al Gore’s character, little or none of which was true, much or all of which was deeply cynical and dishonest itself – yet all of which, when taken cumulatively, had its intended effect.) And now here was this ad ripping Bill McBride. Janet, Janet, I thought, watching it. How could you let your campaign consultants talk you into this? You? And then, because I watch these things closer than most, I saw in the fine print in the ad’s waning second or two, at the bottom of the screen, that it was paid for not by the Reno campaign, but by that of Jeb Bush.
Yes, one might say (before you all e-mail me to say it) that Gray Davis, hoping to run against Bill Simon instead of Dick Riordan, did the same thing to Riordan. But I would reply that, in the first place, that doesn’t necessarily make it right. And that, in the second, the Riordan snippets I saw were about issues, not character assassination, and it seems to me that’s quite different.
My apologies to those of you who missed Friday’s column – Dow 5000 – because I posted it late.
For those who did catch it . . . if you thought Bill Gross’s comments were depressing (‘stocks stink’), how about these, from John Mauldin, released a day later? Mauldin notes, among many other gloomy things, that:
It is not inconsistent to project a slowly growing economy and a secular bear market. The US economy grew at almost exactly the same rate from 1966-1982 as it did from 1982-1999. The stock market was flat in the former period and up over 10 times in the latter.
The big difference in those two roughly 16- or 17-year periods, of course, was that interest rates rose dramatically in the first period, to a peak of about 15% on the Treasury’s 30-year ‘long bond’ in 1981 or ’82, and fell dramatically in the second. (Today the long bond yields under 5%.)
Another difference was that most of the young money managers had no personal memory of a long, grinding bear market to make them cautious (they do now).
So it’s possible that we are now three or so years into 16 or 17 tough ones.
I’ll never forget all the gloomy predictions of The Coming Bad Years, by one hugely best-selling author, in 1979, just as things were about to get a heck of a lot better . . . followed shortly thereafter by his Survive and Win in the Inflationary Eighties, published in 1980, the start of what would be remembered as the disinflationary Eighties. I have a whole shelf full of these kinds of books – let us not forget Ravi Batra’s The Great Depression of 1990, presciently foretold in 1987 . . . except that the Great Depression of 1990 never came.
So in the first place, we can say with some assurance: no one knows.
In the second, it is always worth remembering that the gloomsayers are rarely the only ones who see the problems ahead. There are some awfully smart central bankers and finance ministers around the world who see them too, and have considerable power, though admittedly nowhere near complete power, to change course. So, sure – we might be headed for catastrophe if we never did anything about it . . . but often we do do something about it.
My friend and B-school classmate John Hook sends some of us his sophisticated weekly market review, from which I excerpt this gripping set of hands (which we might nickname ‘the one’ and ‘the other’). Some of the jargon may not be familiar to you, but most of it becomes more or less self-evident from the context. John summarizes . . .
The bear argument is that:
1) Valuations are very high
2) There was no capitulation;
3) Sentiment is too optimistic; and
4) Valuations revert to below the mean in bear markets.
The bull response:
1) Yes, most valuations are very high. But reversion toward the mean will probably occur more from profit increases than from stock price decreases because there will probably be no oil shock, depression, or war defeat to further crash the markets now that the economy is recovering.
2) There was capitulation. Implied volatilities soared to crisis highs and reversed back down. Volume went to record highs. Interest rates fell to forty and sixty year lows. P/Es relative to interest rates fell to 1960 to 1970 levels. Bearish sentiment exceeded bullish by 50%.
3) Sentiment can recover quickly. This is not the 1930’s Depression nor the 1970’s two OPEC Embargoes that quadrupled and then tripled oil prices.
4) Valuations did not revert to below mean in the 1962, 1969-70, and 1990-91 bear markets.
1) Japan had six bull rallies in its ten-year bear market [which appears now to be in its twelfth year and not yet to have ended – A.T.]. Consolidations after burst bubbles take sixteen (1965 to 1981) to twenty-three (1929 to 1952) years.
2) Mutual fund liquidation has been as yet small. Ditto for foreign investment. These liquidations will occur and crash the markets.
3) Capitulation only occurs when everyone gives up. This has not occurred.
4) Valuations revert to the extreme lows after burst bubbles: in the 1930s and progressively in the 1970s until P/Es were at 7 by 1981.
More important that the fact that a bubble burst is the state of the economy. This is not the 1930s Depression or the 1970s stagflation. We have low inflation and moderate growth. There is no reason for the capitulation and sentiment pattern of the 1930s and 1970 to appear. The better analogy is to 1962, 1969-70, and 1990-91 when P/Es gradually came down as stock prices increased not quite as fast as profits.
Brave prognosticator that I am, my guess is that the true answer could lie somewhere in between: that we could be in for a bunch more rough sledding . . . but that – potentially at least – our technological advances and increased experience and safeguards since the 1930s (things like Federal Deposit Insurance, for example), and even since the 1970s, could keep things from being terrible. Let us not forget that Moore’s Law has been broken . . . (but in the most remarkable way! Computing power is no longer doubling every 18 months, as Moore’s Law prescribed – how could that possibly continue, after all? – but rather every twelve months now, or so I have read) . . . and that technological advance is a key driver of productivity growth . . . and that productivity growth underlies profit and prosperity.
So the truth is, no one knows. But it is not a time to buy stocks on margin or to buy stocks thinking they must all be cheap because the market is ‘so low.’ The market is not so low. Much of it is still quite high; and even if it were not, markets tend to ignore ‘fair value’ in both directions. We know we’ve had the euphoric over-reaction on the upside. It’s not clear whether we’ve had the despairing over-reaction (also known as the ‘capitulation’) on the downside. Or whether it’s inevitable that we must.
I promise to be more upbeat the rest of the week. And briefer.
Quote of the Day
The abdomen, the chest, and the brain will forever be shut from the intrusion of the wise and humane surgeon.~Sir John Eric Ericksen, Surgeon-Extraordinary to Queen Victoria, 1873
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