Is the Stock Market Really Dying?

04-Sep-2012

I like this.

By







Pessimism is often most widespread when a long period of economic troubles is nearing an end. What follows can be a surprisingly strong rebound.

The American Theater has been declared near death so many times that Broadway has been nicknamed “The Fabulous Invalid.” Now the same sort of attitude seems to be developing toward the stock market. Smart commentators no longer view equities as the automatic safe choice for the core of a long-term portfolio. And many individual investors seem to agree. They are yanking money out of the stock marketat the fastest rate since May. But just as there has never been anything wrong with the Broadway Theater that a hit show wouldn’t fix, there’s nothing wrong with stocks that can’t be fixed by an economic recovery and a fresh bull market.

Admittedly, there’s a lot to feel bad about nowadays – persistently high unemployment, devastated housing prices, and an economy growing at less than half the rate that’s normal following the end of a recession. Even worse, the stock market looks increasingly risky. The disastrous Facebook initial public offering burned many aggressive investors. And more recently, erratic computer trading has caused extraordinary short-term volatility in the prices of blue chips. So a somewhat downbeat outlook is understandable.

Today’s pessimism comes in a number of different forms, however. In his column “Watch Out for a Correction – or Worse,”  Mark Hulbert argues that the stock market has rallied over the past few months and that sentiment among traders and newsletter writers is now overly enthusiastic. But that’s just a warning about a possible pullback, not a negative assessment of the long-term prospects for equities.

The Wall Street Journal’s Jason Zweig is more concerned about the erratic price swings caused by faulty computer trading. Recent volatility creates the “sense of markets spinning out of control and trading machinery going mad,” Zweig writes. And he adds, “The hearts of many small investors have been broken by the serial setbacks of the past few years.”

The most extreme view, however, may be that of Pimco’s Bill Gross, who compares today’s stock market to a Ponzi scheme. Corporate profits have been growing at the expense of workers’ incomes since the 1970s, says Gross, and that trend can’t go much further. As a result, stocks will be unable to provide the returns in the future that they have in the past. Belief in equities as long-term investments is dying, says Gross, “like a once bright green aspen turning to subtle shades of yellow then red in the Colorado fall.”

So can stock investors look forward only to falling leaves and broken hearts? That’s way too melancholy, in my opinion. Transient market volatility and the possibility of a short-term market correction have no effect at all on long-term returns. And Bill Gross’s argument that the long-term case for stocks has collapsed seems bizarre. Consider the following:

Facebook is not the stock market. Financial journalists tend to focus on companies that are interesting to people who don’t necessarily invest. So there’s much coverage of social media and movie companies, but little about boring electric utilities unless a nuclear plant blows up. Yet retirement savers and other long-term investors should be buying utilities, not Facebook. And over the past two years, such high-yield stocks are up 16% to 20%.

This is an odd time to turn negative. It would be easier to understand an upsurge in pessimism in 2009 when the economy was tanking and the unemployment rate surged past the 10% mark. But now the worst appears to be over. However disappointing, the economy is slowly expanding. Moreover, those improvements are reflected in share prices – the S&P 500 has doubled from its 2009 low.

Stock returns average out in the long run. Growth in U.S. real GDP averages out to a fairly consistent rate over long periods of time. The profits of blue-chip corporations grow a bit faster. And share prices ultimately follow earnings trends. Gross’s argument that high stock returns are largely the result of corporations benefiting from stagnant wages ignores the fact that stocks also did well after World War II when unionized labor was claiming a bigger slice of the pie. In fact, stock returns have shown great long-term consistency for more than a century in all sorts of economic environments. There are decades when stocks perform badly, but eventually they make up the lost ground.

Indeed, pessimism often reaches a climax not long before a troubled stock market finally hits bottom and then begins a major advance that lasts for a number of years. The classic example is the famous 1979 Businessweek cover story “The Death of Equities,” which came out less than three years before a massive bull market began. After 10 years of stagnation, the Dow tripled between 1982 and 1987.

There’s no guarantee, of course, that stocks are going to triple over the next five years, just because the past decade has been disappointing. But there are plenty of giant companies around with decent growth prospects, yields over 2.5% and P/Es below 16. For investors who aren’t trying to be wise-guy traders but just want to build their net worth over a period of decades, the case for owning those sorts of stocks looks just as strong as it’s ever been.

 

Is the Stock Market Really Dying?


Tags: , , , , , , , , , , , , ,

Post a Comment

Your email is never published nor shared. Required fields are marked *

*
*

Subscribe without commenting