Well, IS the Stock Market Safe Again? January 7, 2003February 22, 2017 The market is never safe – as in, ‘risk-free’ – but that’s not news. It is always relatively safe for those with a very long time horizon (but that’s not news, either). Safer still for those able to keep investing periodically over that long time horizon. If you’re 23 and planning to put 10% of your income into the market each month for the next 40 years, to gradually withdraw it over the 35 that follow, who cares where it goes in the next five or ten? Indeed, the lower the better. Just sit back and enjoy the relative certainty that if humans have a future (increasingly a question, but still a good bet), you should do fine. Even more fine if you put perhaps a third of your funds into international markets, not just the U.S. But what if you’re 63, not 23? Is it safe? Is it safe? You have surely heard by now that the last time the stock market fell three straight years was forever ago, and that the chances, thus, of its falling yet a fourth year – let alone in the third year of a presidential term (when any president will pull out all the stops to assure reelection, and in this case has majorities in both houses of Congress to help him) – are slim indeed. Or so many say. A financial writer interviewed on the Today Show this past Saturday, whom I will not embarrass by quoting him by name, all but guaranteed it. (‘Nobody wants to invest in the stock market right now which tells you what? That’s where the bargains are right now!’) But is the Dow a bargain at 8600? Disclaimer: Obviously, I don’t know. Still, consider that this past Friday, Japan’s Nikkei Dow closed at 8578, down from a hair under 40,000 thirteen years earlier, and that our own Dow closed at 8601, up from 2700. Theirs had fallen 78% after 13 years, ours had tripled. If you had asked people in January, 1990, when, if ever, they thought the US Dow, at 2700, would overtake the Japanese Dow, at 40,000, few would have guessed ‘a dozen years.’ (Friday, by the way, was not the first day this happened. The two have been dancing around each other for some time.) Gee, time flies when you’re having fun. I’d venture to guess that the ’90s flew by a lot faster in Omaha than in Osaka. So: Was the US market as preposterously overvalued at the start of 2000 (when it finally cracked) as the Japanese market was at the start of 1990 (when it finally cracked)? On the whole, no. Only the wildest sectors of our market were. Those sectors are better reflected by the NASDAQ than the Dow – and the NASDAQ is down from 5200 to 1400. But thirteen years earlier, it was 450. So, like the Dow, it, too, has about tripled since 1990. I am not suggesting that we face the same fate as Japan. (And I am not suggesting that you sell the US Dow to buy the Nikkei Dow. Even after 13 years, Japan may not be out of the woods.) I am just looking for points of reference. Here is another one. I have trotted it out in this space many times before: On December 5, 1996, just a little more than six years ago, Fed Chairman Alan Greenspan and Treasury Secretary Robert Rubin had become so concerned with the breathtaking, relentless, unsustainable rise in US stock prices that Greenspan floated his famous ‘irrational exuberance’ phrase. It was carefully oblique, but, as we know from reading (or listening to) Bob Woodward’s Maestro, it was also quite intentional. With the Dow having soared to 6500 and the NASDAQ to 1250, Greenspan and Rubin were really worried. (In hindsight, one of Greenspan’s rare mistakes, I think – but a big one – was not using the Fed’s power to raise the margin requirement from 50%, where it has been for a very long time, to 55% or 60% and gradually even higher, if need be. True, such a measure would have been largely symbolic. Anyone wanting to gamble on rising prices could just have substituted options for direct stock ownership and skirted higher margin requirements that way. But in markets, signals and symbolism are important. Had Greenspan sent this one, the bubble might not have inflated as far it did, and thus the ‘dislocations’ and subsequent hangover might not have been as bad. At worst, sending this signal would not have worked – but would at least have spared some naïve small investors, who were heavily margined, a portion of the wipe-out.) So what has happened in the six years and one month since Greenspan gave us that handy reference point at Dow 6500 and NASDAQ 1250? We’ve worked hard, we’ve invented amazing stuff (TiVo!), we’ve laid a zillion miles of fiber optic cable (that is only 3% utilized now, but may well find fantastic uses in the decade ahead) . . . we’ve even had a smidgeon of inflation . . . so perhaps 6500 and 1250 are no longer so irrationally exuberant. Maybe we’ve grown into those valuations. In which case, the Dow would have only about 24% to drop from here, and the NASDAQ 10%, to return to fair value. The problem is that markets tend to go to wild extremes beyond fair value in both directions. It’s not an immutable law, but it’s linked to human nature, which doesn’t change. So just as “fair value” was of absolutely no interest to investors as the Dow shot past 6500 to nearly 12,000, and as the NASDAQ shot past 1250 to 5200 . . . so must one be prepared for the possibility – not the prediction, the possibility – that it may disregard “fair value” on the way down, as well. One big difference from six years ago is that interest rates are lower. Indeed, the lowest they’ve been in 37 years. But about the only way they could go much lower still, it seems to me, is if they were to do so for “bad” reasons. (Rates have long been, for example, very, very, very low in Japan.) That would not augur well for stocks. And if interest rates should head up, that could be a problem for stocks, also. Another big difference from 1996 is that instead of our being in the midst of a long trend toward lower unemployment and lower budget deficits (surpluses in 1999 and 2000!), we instead find “all the numbers that we’d like to see going up going down, and all the numbers we’d like to see going down going up.” And a $450 billion balance of trade deficit. And huge deficits at the state and local level. And a lot of people borrowing against home prices that have risen 40% since 1997. We are becoming increasingly disliked around the world, compared with 1996, which is an intangible thing but likely to have its costs. (Could we not have acknowledged the importance of the Kyoto accord and taken a more conciliatory tone, even while requiring modifications before signing it? Could we not have begun with a multilateral approach to Iraq rather than having had to be pushed to it?) The fleeting peace dividend of the ‘90s is being replaced by the military’s rising share of our GDP. (If bigger military budgets improved national economies, the USSR, instead of collapsing, would have become the world’s most prosperous nation.) It can’t be good for the economy to have 250,000 reservists plucked from their jobs and their good incomes. Most of South America is in scary shape – and Europe and Japan have problems. Beefing up domestic security – at airports to take just the most obvious example – may well be necessary, but is not likely to make us more prosperous. As the populations of the industrialized countries age, the demographics become a challenge to prosperity. There’s preserving Social Security and shoring up Medicare. But there’s also the question of where the demand will come from, a decade or two from now, to absorb all the shares we baby boomers will want to sell off to supplement our retirement. And all this is before imagining something really bad, which is actually not all that hard to imagine. So, yes, in some ways things are a lot better than they were in 1996. But in more than a few trivial ways they are not. Is the Dow, up 32% from its irrationally exuberant level of 1996, a bargain? I am an optimist. Not only will “the sun come out tomorrow,” the days are getting longer. Have you noticed? I have! I love that! I never imagined the US and the USSR would annihilate each other. And I like to think we will meet most of our contemporary challenges in at least a vaguely sensible and successful way. (Who will buy our Intel, IBM and Coke as we sell off shares in our dotage? Well, among others, a billion newly middle-class Chinese and Indian households saving for their retirements, I like to think.) Technological progress only accelerates, as more and more pieces of the puzzle fall into place, and this is force that – for all the very real risks and challenges it poses – has the potential, at least, to solve almost any economic problem. In short, it’s possible that things will go well. There will be no major terrorist event to disrupt our economy. The war in Iraq will be averted (or won easily to the cheers of an Iraqi population eager to embrace peace and democracy). Venezuelan oil will begin flowing again, averting an oil shock. Business activity here and abroad will begin to rev up, adding jobs, cutting deficits, and putting us back into the happy vortex (do I mean vortex?) of a virtuous cycle. But just as the in the once-in-a-lifetime bull market of the ’80s and ’90s people learned that every pullback was a chance to jump in (because it would always bounce back and go higher), people in bear markets come to view every rally is a chance to bail out. It takes a fundamental shift in psychology for greed to, once again, gain the upper hand over fear. It will happen – too many people are working too hard toward that end for it not to happen, and the natural bias of our economy is to grow ever more productive and prosperous. But with the Dow and NASDAQ already higher than they were at their irrationally exuberant levels of 1996, I don’t see either one of them as offering the kind of bargain-basement, mouth-watering opportunities – the astonishing dividend yields and fire-sale price/earnings ratios – that tend to mark the end of a bear market. There are always exceptions (and with hindsight, we’ll know precisely which they were); but, even as far as it’s fallen, much of the market still ain’t cheap. I hope I’m wrong. It would hardly be the first time.