Weekly Editorials Page
8/30 to 9/5, 2001

Previous Weekly Editorials

9-6-2001:  Stock Market Super-Cycles (continued)      Now the question of the hour is: are we heading into a 16-year super-bear-market (known in the trade as a secular bear market) that will last until 2016? If so, the stock market might be expected to reach bottom next year, and to peak during the presidential election year of 2004. However, through 2016, succeeding peaks would be comparable to, or less  than the peaks in the various market indices reached in 2000. If so, the next stock market rise through 2004 would be a good time to liquidate one's equities, and to invest one's money in short-term money market instruments. On the other hand, there are some indications that the market will recuperate by next year. However, the stock market is a major leading indicator that usually begins a meteoric rise about 6 months before the economy actually turns up. So far, that hasn't happened. In the meantime, layoffs are continuing around the world. Of course, Uncle Sam is usually the locomotive that pulls the rest of the world back to prosperity, and it may work the same way again this time. Just because things have worked in such-and-such a way in the past doesn't guarantee that they'll continue to work that same way in the future. On the other hand, this time it was going to be different. This time, the baby-boomers were saving for their retirements, and their money flowed automatically into mutual funds each month. Awash in a steady influx of funds, the stock market was going to go up and up and up, inflating stock prices without regard to the usual standards of prudent investing. Besides, productivity was increasing at an upper-single-digit rate, so that one could make a case for such lofty stock valuations. Guess what? In 2000, the music stopped, and showed us once again that the stock market tricks even the experts.
    I don't mean to alarm anyone with this 16-years-of-bad-luck scenario. If it happens, we'll have a good chance to exit the game between now and January, 2005, after recovering at least part of what we had in the summer of 2000. It would still be possible to make money by selling stocks at market highs and buying them back at market lows, although a better strategy might be to invest in short-term interest-bearing instruments, since stocks would have a bumpy ride.
    (For those who have money to invest and who want to put that money in equities, now might be a suitable time to pick up some "fallen angels" off the bargain table. Just as everyone wanted well-run dot.com companies a year ago, now, no one wants them, making it a good time to act contrary to the crowd.)
9-5-2001:  Stock Market Super-Cycles  
    Tonight, my song-and-dance routine is about the 16-year super-bull-markets and the 16-year-super-bear-markets that have characterized the stock market at least as far back as 1870. A few years ago, I came upon a stunning exposition of this subject of long-term behavior of the stock market on the Internet at http://cpcug.org/user/invest/bigpic2.html, written by "Harry Rood". At the time he wrote this (1997), the stock market was overvalued. From there, it proceeded to continue to engorge further until it became a bubble that was only pricked last year.

    The grand total output of all the companies in the U. S. is essentially the gross domestic product. The total value of all the stocks of all the companies in the U. S. is basically the sum of the prices of all the stocks of all U. S. companies. The total annual average rate of return on all U. S. stocks consists of
(1) dividends,
(2) gains in real productivity,
(3) monetary inflation,
(4) stock price inflation and deflation.
    Of these, only the first two represent real gains in the stock values. The latter two are distracters that tend to obscure what's really going on. The first of the real gains  (dividends) varies from 7% of the values of the associated stocks at the bottom of a stock market trough, when stocks are undervalued, to about 2.8% at a stock market crest, when stocks are overpriced. To say that in a more meaningful way, dividends don't vary much except to slowly rise. It's the stock price that varies, partially because of stock price inflation and deflation. Stocks are sold at auction in accordance with the law of supply and demand. In bad times, when the economy is in recession, stocks become relatively cheap  Then once the economy is rolling along again, stock prices are bid up and up, with everyone eager to buy them, until the next downturn occurs and the stock market suddenly dives again. The range of stock-price inflation is about 7/2.8 or about 2.5 to 1. At a stock market peak (which typically occurs when the economy is in its best form and everyone's optimistic), a "market-basket" full of big-name stocks will usually sell for about 2.5 times what that same market basket of stocks would fetch at a stock market bottom (which typically occurs at the darkest, scariest hour of a recession).
    Obviously, the time to buy stocks is when they're deflated, but at those times, fear gets in the way.
    Obviously, the time to sell stocks is when they're inflated, but at those times, greed gets in the way.
    In addition to real gains in the values of stocks, inflation also raises stock prices by a few percent per year, although this doesn't represent any real gain in buying power.
    Now for a shocker! The average inflation-adjusted rate of rise in stock values over the period from 1870 to the present is only 1.5% to 2% per year! Some years have seen larger gains than this, but during recessions, these rates of rise can actually go slightly negative. 
    To this may be added the average dividend, which, as stated above, is anywhere from 2.8% a year to 7% a year. Add to this the 1.5% to 2% rise per capita productivity and 3% for inflation and you arrive at an average, annual stock market rise of about 7.3% to 12% a year. "Whoa!", you say. "What about the last few years, when the stock market has risen 25%, 30%, or 40% a year?"
    Two factors have made possible the extraordinary stock market gains of the past few years:

(1)  Real productivity gains in the upper single digits have seemed to have been taking place. (These gains are now being questioned, and perhaps, retroactively downsized.), and
(2)  Stock prices have set new records for price inflation.
    I mentioned above that dividend yields can get as low as 2.8% when stock prices have hit a cyclic peak. Last year, dividend yields hit what I believe was an all-time low of 1.8%. In other words, stocks have never been so overpriced... so expensive for what you got... as they were last year just before the dot.com bubble burst.

(To be continued)

Preview of tomorrow's section:
    1929 was the year of a super-bull-market peak. From there, prices dropped like a runaway elevator from 400 on the Dow in 1929 to 40 on the Dow in 1932. Then a long slow climb began. 1966 was the year of a super-bull-market peak (37 years after the 1929 crash). After 1966, prices dropped again for the next 16 years, rallying in the presidential election years of 1968, 1972, and 1976, but (after correcting for inflation) working their way steadily lower. Stock prices finally bottomed 16 years later, in August, 1982, at a value in inflation-adjusted dollars, that was less than one-third that of their peak in 1966. Then they began a long climb, punctuated by major corrections and the stock market crash of 1987. 1998 was the year when they should have hit a 16-year super-bull-market peak, but everybody was having too much fun at the party, and the downturn didn't occur until the year 2000.