Wednesday, May 16, 2012

“Markets – Are Things What They Seem?”

Sydney M. Williams

Thought of the Day
“Markets – Are Things What They Seem?”
May 16, 2012

On August 13, 1979, Business Week published an issue that became famous for its cover story, “The Death of Equities.” From the article: “At least 7 million shareholders have defected from the stock market since 1970, leaving equities more than ever the province of giant institutional investors.” Further on: “Younger investors, in particular, are avoiding stocks.” As inflation hedges, stocks failed investors. During that decade, stocks compounded at 3.9%, while the CPI grew at 6.5%. In contrast, according to a Salomon Brothers report, the price of gold compounded at 19.4% and diamonds at 11.8%. Bonds fell in price, with the yields on AAA Corporates rising from 4% to 11%.

On May 15, 2012, the lead editorial in the New York Times, read “End of the Affair?” “Investors are shunning the stock market,” began the editorial. The Times’ editors wrote of the absence of trust and confidence, and that there is a feeling that “the market has become increasingly unfair.” They wrote that stocks had risen 10% since March 2000, “a paltry gain.” (While their point is correct, the Times facts are wrong. The S&P 500 is actually 10% lower today than it was at the end of March 2000.) More importantly, stock prices have compounded at 2.3% over the past ten years, while gold has compounded at 17.2%. Bonds have risen in price, with the yield on the Ten-Year falling from 5.04% to 1.78%.

When one looks back over the past one hundred years, there have been three times when stocks have lost favor for extended periods of time – the 1930s, 1970s and the decade just passed. The first two periods were followed by very different wars and extended periods of growth. The 1940s saw the greatest destruction of human life the world has ever known, as forces for democracy defeated maniacal despots of Nazism and Fascism. The 1980s saw the forces of freedom finally prove victorious over the tyranny that was Communism in a Cold War that lasted forty-four years, and culminated without a shot being fired. In the first instance, economic and stock market growth was accompanied by gradually rising interest rates and inflation, a period that lasted twenty-five years. In the second, interest rates and inflation both fell over three decades.

Long-lasting rallies always begin from deep wells of skepticism. If that were not the case, as a wise friend of mine once put it, then tops would be bottoms and bottoms would be tops. Perhaps the fundamentals may not yet be in place to allow for a long lasting revival of markets and economies, but skepticism appears widespread. It does not show up in the VIX, which seems to suggest complacency, not concern. Nevertheless, the last four years have seen $400 billion drained from equity mutual funds. The percentage of U.S. households owning individual stocks or stock funds has declined from 59 percent in 2001 to 46.4 percent in 2011. During a time (March 2009) to the present that saw the Wilshire 5000 add $9 trillion in value, individuals have been net sellers. Will the next couple of decades be similar to the 1950s and ‘60s? Nobody knows. History may not be a compass, but it is a guide.

Harvard philosophy professor, George Santayana, warned that “those who do not learn from history are doomed to repeat it.” Clarence Darrow once acknowledged that, yes, history does repeat itself, “and that’s one of the things wrong with history.” In fact, what Mr. Darrow was observing was that we ignore what history teaches us. We evolve technologically, but emotionally we are the same people we were 2000 years ago, governed by the same feelings of guilt, love, hatred, greed, generosity, fear, honor, etc. We extrapolate rather than analyze. We react subliminally to recent events rather than objectively to a diligent study of the past. Behavioral economists suggest such people are suffering from a “recency bias” – they fear another melt down ala 2008-2009.

I am not unmindful of the pitfalls facing us. We have lived a charmed life for a long time, for many of those years riding the back of a debt monster that seemed imbued with everlasting life. From the end of World War II to the fall of the Berlin Wall, the United States served as a beacon for those who would choose freedom over oppression. However, we live in a world that remains dangerous, with rogue nations developing nuclear weapons and with terrorists still intent on killing innocent Americans. We must make tough decisions regarding entitlements we cannot afford, yet too many in Washington and state capitals prefer to look the other way, hoping that their fiscal problems will simply go away. Europe’s unfortunate unraveling affords us the opportunity to face the hoary monster of socialized democracy head on. Yet there are still those in denial.

We have an administration that has chosen ideology and social issues over meaningful fiscal reform – gay marriage versus 12.5 million unemployed Americans – and a Congress that has determined that obstruction is preferable to conciliation. Without fiscal reform, we face an impending crisis of rising taxes in a feeble economy. We have a media more interested in a fifteen year-old’s behavior, rather than evaluating the policy responses of the same person, as he campaigns for the Presidency.

There is also the question of time. While the market bottomed in June 1932, it was not until late 1954 that the Dow Jones breached the 1929 high. Of course, a worldwide depression covered the globe for much of the 1930s and a world war cost about 100 million lives in the first half of the 1940s. In the 1970s, it took 16 years (1966-1982) before the Dow Jones pushed meaningfully through the 1000 level. In our current situation, the S&P 500 reached 1517 in March 2000 (The market did go slightly above that level in October 2007, but for my purposes that was resistance.) It remains to be seen how long it will take to start another major leg up. Are we, to paraphrase Churchill, at the end of the beginning, or the beginning of the end? I don’t know, but I do know we are not at the beginning of the beginning of the downturn. That happened twelve years ago.

Macro events swirl about our heads, demanding our attention and becoming the topic of conversation, especially when they carry a negative tone. War, accidents and murder sell far more ad dollars than peace and reconciliation. Nevertheless, and hidden from sight, people’s lives go on and businesses function. Real life is not unlike the opening scene in “Our Town”, as the stage manager details the dull, boring, but necessary habits of living. Investors should be wary of getting too caught up in the emotions of the moment. But, keep in mind that while it is fun to poke fun at the editors of Business Week who brought out that infamous publication thirty-three years ago, the eighteen-year bull market did not begin until three years later. Three years is a lifetime for a trader and even a very long time for a nervous investor. If answers were simple, we would all be rich; so let old fashioned common sense dictate your behavior. Remember your history, but be aware of the present.

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