Thoughts on the Market

But first . . .

NEW MEANING TO THE TERM ‘DOUBLE HOMICIDE’

Gennaro Nunziato: ‘As I was passing through the security check at Newark airport two weeks ago, carrying two disposable lighters, I was told that only one lighter would be allowed; the second was confiscated. Not quite sure why one lighter would be allowed but two wouldn’t, but there does seem to be some sort of half-baked regulation in place.’

☞ Just one lighter? Well, THAT’s standing up to the tobacco lobby!

HERE’S HOW COME

Chris H: ‘How come you’re not so tough on DNC Chair Terry McAuliffe’s path to riches as you are on Bush and Cheney???’

☞ Because he’s not President? Because he’s not Vice President? Because no one has accused him of possible insider trading or accounting manipulation? Because he wasn’t on the Global Crossing board and he wasn’t its CEO (as Bush was on Harken’s board and three-man audit committee and Cheney was Halliburton’s CEO)?

And now . . .

WELL, SO IS THIS THE BOTTOM?

Brian Williams – a smart guy – put it this way as he led off last night’s NBC Nightly News: ‘It hasn’t been this bad since 1997.’ Or at least I thought that’s what he said. And to a normal student of the English language, that would suggest it was pretty darn bad in 1997. No? But actually the Dow – which finished down 3% yesterday to close at 8813 – was under 8000 for much of 1997. Far from people feeling rotten about the market in 1997, they were thrilled. It had been more or less shooting straight up for years.

If you go back to 1997, you will not find that people thought the market was low, you will find that people thought the market was high! Two people thought it was so high, in fact, that one of them – Alan Greenspan, chairman of the Fed (the other one being Bob Rubin, Secretary of the Treasury) – had given a speech the previous December, when the Dow was 6500 and the NASDAQ was 1250, floating the phrase ‘irrational exuberance,’ and hoping somehow to moderate what had been an amazing, perhaps unsustainable multi-year climb.

Now, in thinking back on it, maybe what Brian Williams said, or at least meant, was that there hadn’t been a point drop in the Dow this bad since 1997. I’m not sure, and it doesn’t matter, and you’re not paying me enough to get me to look it up.

The point is, everyone’s talking about the trillions of dollars that have been ‘lost’ in the stock market as if they were ever really ours.

Not to minimize the seriousness of the situation or the pain. But relatively few people had all their money safely in the bank waiting for the peak of the market and then, at the peak, put it all into dot-coms.

Some did. The least sophisticated investor usually gets in at the very top, or close to it, and out at the bottom. But I know someone who bought 24,000 shares of Erickson at $1.67 in 1994 (adjusted for splits) and sold a third of it in 1998 for $8 a share. Then held as it peaked around $25, and holds it even today as it has fallen all the way back to $1.62. Has that person lost a fortune? Been the victim of cruel market forces? Well, in one sense. But just how bad an eight years was it? He more than quadrupled his money on a third of the stock, about broke even on the rest. That’s a little different from having put your all into ERICY at $25 and then seeing it fall to $1.62.

In any event, the question is not how far ERICY and 5000 others have fallen, but whether it’s worth more or less than $1.62 today. And I don’t have an answer. But I know this much: it’s likely to be a lot closer to its true value at $1.62 today (or at $1.67 in 1994) that it was at $25 the Spring of 2000. It was irrational exuberance! It was a bubble. We will not see the likes of it again, on such a wide scale, for 30 years.

Are things terrible now that the Dow is only 10% or 12% higher than it was in the summer of 1998?

The answer is that most of the big U.S. stocks still sell at historically very high multiples of their earnings. And that even if today’s prices are ‘fair,’ what normally happens – I can’t say it will happen this time and hope it doesn’t – is that just as stocks rise way above their sensible price levels in eBULLient markets, so do they generally fall way beneath their fair value in unBEARable markets.

‘Fair value’ is a very squishy number, based on all kinds of unknowable assumptions, and it varies greatly with the overall level of interest rates (and expected interest rates). So I’m not saying I know what it is. But like many people, I can sense the extremes. Most stocks today are no longer wildly overpriced (very significantly overpriced in many cases, no doubt, but rarely wildly overpriced) . . . but neither are many of them wild bargains (significant bargains, perhaps, in some cases, but not wild bargains).

I looked back at some of the columns I had written in this space in 1997, to remind myself of the mindset at the time, and of course most of the columns I found were about ostrich meat or some other damn fool thing no one wanted to read about then and I surely didn’t want to read about now. But I did come across a column from October 17, 1997, called ‘Scary Expectations.’

A study had found that investors expected to see their stocks appreciate 34% a year in the decade ahead.

The first thing to say [I wrote] is that there will almost surely be a tremendous number of disappointed investors ten years from now. No way is the Dow headed for 149,000 in ten years (today’s level compounded at 34%).

The second thing to say is — AEIEIEIEIE! Which may be misspelled, but is roughly what the cavalry used to say when they spotted twenty thousand Indians coming over the ridge.

Another applicable phrase might be: irrational exuberance.

This is not to say there will be a crash, or that our outlook in America is not bright. But one sure sign the market is not poised for unprecedented appreciation over the next decade is that so many people apparently believe it is.

I was at least temporarily wrong then – the NASDAQ, especially, just catapulted higher and higher (which is why it has fallen further and further) – and I may surely be wrong now.

Yesterday’s close may have been the bottom.

I strongly doubt it – but I have not sold all my stocks, and you shouldn’t sell all yours either, if you’re in it for the long haul. Indeed, if you are fortunate enough to be in your twenties or thirties, putting something into stocks every month, you should rejoice if and as the market drops lower. The shares you buy will be ‘on sale!’ Good news!

The further good news, as my pal the estimable Less Antman points out, is that with the S&P 500 now at 920, it is significantly undervalued according to the Greenspan model that produced the original “irrational exuberance” comment. Instead of 920, it should be at 1215 ($56 estimated earnings divided by the 4.61% 10-year T-note yield equals 1215). And, says Less, with pessimism so high, it seems logical to believe that we ARE close to a bottom. Even if we’re not, he argues, the risk of being out of the market, if you’re a long-term investor, is too great.

I am older than Less; I lived through a long bear market that he missed – a market in which one could not possibly imagine it’s going any lower, as day after day it did (the exact mirror of the late-Nineties bull market). What’s more, it’s hard to picture how the war on terrorism, with all the uncertainty (and drain on productivity) it entails, could be quickly or definitively won – unlike the Gulf war.

Not to mention some of our other problems. It’s a lot easier to imagine inflation and interest rates rising from here than falling. What would that do to the 4.61% divisor in the Greenspan model? It’s a lot harder to see how companies will make their investors juicy profits when the Internet makes comparison shopping so easy, and price competition so brutal.

So don’t throw caution to the wind and – as one of you proposed to me in an e-mail last night – begin investing with borrowed money, on margin. You might win, but I don’t believe it’s wise to take the risk.

If you’re in it for the long haul, ‘stay the course’ with at least a significant chunk of your stock-market money. Take tax losses if they would be helpful, but put most or all of that money back to work in different stocks or funds. Consider putting some of your money into foreign markets or international funds, if you haven’t already, to help spread the risk and because some of those markets may offer better value (could it be Japan’s turn again for a while?). But hang in there and average down. The more universal the despair and disillusionment, the less reason to sell.

The problem, a group of market sages on my living room couch a month ago for PBS agreed (did you see us on the News Hour? Adam Smith, Jim Grant, Carol Loomis, Allan Sloan, and My Three Chins?) is that this appears to be a most unusual duck – namely, an ‘overvalued bear market.’ Stocks are not supposed to be overvalued in a bear market . . . but by many traditional measures they still are.

‘The inevitable direction of the market is up as long as capitalism survives as a system,’ Less fires back. (He wasn’t on the couch; he’s not old enough to be a sage.) ‘If it doesn’t survive, no investment is safe, nor is society. A globally diversified investor who wants to play it safe with his or her long-term money belongs in equities. And the last time I checked, the Market Timers Hall of Fame is STILL an empty room.’

He was saying much the same thing two years ago when the market was much higher. But I’m more inclined to reprint the comment today, with the NASDAQ off by 75%.