|In a recent issue of Barron's,the"Big Money" poll noted that the September 11th attacks didn't seem to dim optimism among money managers. Of those who responded, 68% claimed to be bullish or very bullish on equities through mid-June 2002. Part of this enthusiasm stems from what many of these managers apparently believe will be the positive effects of recent monetary and fiscal stimuli. However, some market observers question money managers' objectivity.
Just how much weight should investors attach to this optimism? Aside from the obvious contrarian sign it may be sending (after all, many of this same crowd were bullish at the top in March 2000), these managers need to be bullish — their jobs, not to mention their management fees, depend on it. Their jobs also depend on consumer confidence. Since the September 11th tragedy, many experts now believe that more than ever the strength of the economy is dependent on the consumer's performance at the mall.
In aggregate, to use a favorite term of economists, just how old are these money managers? When did most of them start managing money? Many were working throughout the great secular bull market in equities that by nearly all accounts started a generation ago. Since most of them missed the top, why should investors believe they will be any more astute at picking a bottom? Those managers may also fail to perceive markets that trend sideways for years, leaving most investors certainly no richer and perhaps much poorer.
THE DJIA PATTERN
There are numerous examples of long periods when stocks went nowhere. In November 1903, the Dow Jones Industrial Average (DJIA) traded at 42.15. In 1911 the DJIA fell to 72.94. Twenty-one years later, in 1932, it was trading for less. In 1937, the DJIA reached 194.40 after bottoming out at 41.88 in the summer of 1932. Twenty-nine years earlier, in 1903, the index traded at 42.15. In 1959, the DJIA hit a high of just over 685. In 1974, nearly a generation later, it dipped lower than 685. A similar story occurred in 1961 when the DJIA moved south of 735. Fifteen years later the DJIA was changing hands at exactly the same price.
To look at it another way, investors who invested in the DJIA in 1966 didn't catch up with the Treasury bill yield until 1986. Small stocks, which are a current favorite of many of today's managers, performed even worse. The point is that from 1965 to 1981, stocks underperformed inflation. Buy-and-hold bulls continually sing the benefits of long-term investing. Few, however, bother to define the term. Sometimes investors seem to wait an awfully long time, only to break even, if that.
SOME THINGS NEVER CHANGE
In 1924, a market observer named Edgar Lawrence Smith wrote a book entitled Common Stocks As Long Term Investments. Smith's thesis was that conventional wisdom about the risks associated with common equities was understandable but incorrect. Smith applied statistical analysis to show that stocks outperformed bonds over the long haul, particularly during inflationary periods. He summarized his position for equities with what many today would recognize as new-paradigm palaver — that is to say, babble. He claimed that corporate management's growing responsiveness to the interests of shareholders and better research from Wall Street assured the nation's equity investors a bright future. Modern-day shareholders of Enron Corp. (ENE) and all those dotcom companies that Wall Street analysts hyped through March 2000 should find little solace in Smith's words.
In 1925, no less an economic heavyweight than John Maynard Keynes gave Smith's book a favorable review. Keynes agreed with one of Smith's major premises: both men believed that the retention of earnings, coupled with the effects of compounding those retained earnings over time, explained the superior performance of stocks over bonds.
Smith and Keynes were not alone in their beliefs. Irving Fisher, perhaps the most famous American economist of the era, concluded: "It seems that the market overrates the safety of 'safe' securities and pays too much for them, that it underrates the risk of risky securities and pays too little for them, that it pays too much for intermediate and too little for remote returns."
In 1994,Wharton School finance professor Jeremy Siegel's Stocks For The Long Run hit the bookstores. It was an immediate success. One reviewer called it the best book on investing he'd ever read and the best reason for buying and holding stocks for the long term. In it, Siegel takes a similar tack to Smith. In fact, he relates the huge effect Smith's work had on investors, citing Smith's belief that even those who purchased equities at the top of a market cycle faced only a 6% chance of having to wait six to 15 years to break even.
Though the DJIA took 25 years before it exceeded the 1929 high, Siegel writes: "It took just over 15 years to recover the money invested at the 1929 peak, following a crash far worse than Smith had ever examined." Curiously, one of the reasons Siegel notes why investors who bought and held did better than the DJIA when it came to breaking even was because of the generous dividend yield on stocks during the 1930s, a condition hardly in vogue today.
According to conventional wisdom, demographics were one of the driving forces behind the recent bull runup; baby boomers had to save for their retirements. But those demographics may be changing. Take a look at Figure 1; it correlates the "saver/spender" ratio with equity mutual fund flows as a percent of nominal Gross Domestic Product (GDP). Savers tend to be those between the ages of 40 to 49, and spenders tend to be those between ages 25 to 34. Simply put, when the number of savers is rising in relation to the number of spenders, equity mutual fund flows also increase faster than nominal GDP. In this setting, stocks outperform inflation. Reverse the situation, and mutual fund flows decline as a percent of nominal GDP, creating an environment where the stock market underperforms inflation.
Figure 1: Momentum in the saver/spender ratio. This ratio peaked in 1996. Likewise, 1996 marked a plateau in equity mutual fund flows. The saver cycle previously topped out in 1966. It's due to top out again in 2004. What followed 1966's high-water mark was a spender cycle when the DJIA was trading around 1000. Sixteen years later when the "saver/spender" cycle finally bottomed, the DJIA was still changing hands under 1000. The only exception occurred in 1987.
So anticipated, moreover, is the US economic recovery from the big monetary and fiscal stimulus packages that it could disappoint when it finally arrives. Look at Japan: interest rates there are at historic lows. Over the past decade. Japan has implemented 10 stimulus packages totaling more than $1.2 trillion. The Japanese unemployment rate bottomed out in 1992 at 2%. Today, it's over 5% and rising. Since 1992, Japan has endured two recessions, and many believe its economy is now headed into a third. Since Japan plunged from its lofty perch in 1989, so far all the fiscal and monetary stimulus of Japanese bureaucrats has failed to restore it. Pundits will argue that the US is not Japan, and in that they are right. But Japanese policymakers and investors do not own the patent on market speculation, economic miscalculation, or policy bungles.
REMEMBER YOUR HISTORY
Over the past several years buying and holding equities for the long haul became a media mantra. It was widely maintained that investors who hold on long enough will always come out even, even if they are not richly rewarded. Still, as Siegel points out, Smith's book appeared at the onset of the greatest bull market in history at that time. Looking at the "savers/spenders" mutual fund flows ratio, savvy investors of the 21st century might do well to remember that Siegel's work preceded an even greater bull market.
Ron L. Ellison is a registered investment advisor and financial planner with RLE & Associates, Newport Beach, CA 92660. He can be reached at 949 261-1740, 877 455-9681, or RLEasset@aol.com.
SUGGESTED READING Smith, Edgar Lawrence . Common Stocks As Long Term Investments, The MacMillan Company.
Siegel, Jeremy . Stocks For The Long Run, 2nd ed., McGraw-Hill. Current and past articles from Working Money, The Investors' Magazine, can be found at Working-Money.com.
Current and past articles from Working Money, The Investors' Magazine, can be found at Working-Money.com.
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