Last year at this time I voiced my grave concern for the U.S. economy. At the time, the stock market was climbing to all time highs. Optimism ruled Wall Street and “experts” everywhere touted the great global economy. Financial crooks and buffoons were making off with hundreds of billions, while our most sophisticated financial institutions were loading up on debt to purchase shady mortgage backed securities.
I took some heat when I issued my warning, as Wall Street marched upward toward the cliff like a pack of lemmings. Today I stand at the edge of that cliff, looking down at the debris scattered at the bottom of that cliff. Man, there’s a lot of detritus down there.
What a difference a year can make. Don’t say you weren’t warned. The mortgage derivative market has been revealed for what it was—a global shell game that was based upon slight of hand. Now, the American Taxpayer must pay the price. And it is steep. I was predicting $1 trillion. Now it looks like that sum might be double that amount.
To put this into perspective, this has added more than 20% to our national debt in a single year. Granted, much of this has been financed by federal slight of hand. Although it might not show up on the books, it will rear its ugly head as inflation. The simple fact is: when you lose money, it’s gone. When you print it, things go up in price. Inflation is coming.
When I was a kid, there was a TV commercial that said, “You can’t fool mother nature.” Ain’t that the truth. Our economy is Mother Nature. Let me explain.
The stock market is little more than the expression of the human condition. As humans, we strive to fulfill our needs. Maslow did a good job in explaining this, and I will give a quick summary here.
1. Our first and primary need is existential. We need to survive. That means we need such things as food, clothes and sleep. If these needs are not met, we die.
2. If we live, our next need is for safety. We feel the desire for protection from the risks to life. We seek to avoid war, sickness, accidents, environmental catastrophes. That sort of thing.
3. Once we feel safe, we strive for something else, socialization. We want to be with like-minded others. We want to be loved and accepted by others.
4. When we are part of a culture and family, we begin to search for higher things, like confidence, recognition and self-esteem. We seek to be seen by others as worthy of something more than basic acceptance or familial love.
5. Finally, once we earn the trophies and have that house and the car, once we have a family to care for and love, we seek to achieve the ultimate human achievement, self-realization: We look for inner peace, happiness and harmony with others and our world.
Here is how this all affects the stock market. We always seek to make our lives better. This leads us to search for new ways to be more comfortable, to make more money, to have more respect from our peers. This leads to
PRODUCTIVITY. Traditionally, our productivity growth ranges between 1% and 4% per year. Things like fire, electricity, the internal combustion engine, the assembly line, computers, the Internet and medicines are all examples of human achievements that have increased productivity and makes our economy grow. For the sake of my example, let’s assume average productivity growth of 2%. This means that the companies that make up our national economy on average would produce about 2% more goods and services each year over and above inflation.
Next, we have
RETURN ON INVESTMENT. Traditionally, the stock market trades as a Price/Earnings ratio of something between 14 and 20. (I know, you are saying, “Jay, what the heck does that mean?) If a company is earning $1,000,000 after taxes, a stock market P/E of 20 would mean that the company “value,” as it relates to the stock market would be $20 million. If there are 1 million shares outstanding, we would have a share price of $20.
i. With an average P/E for the market of about 18, the underlying companies would be earning a 5.5 % after tax return on our investment.
Finally, we have inflation
Inflation typically ranges from zero to 8%. There have been times when inflation has been negative. There have been times when it has been much higher than 8%. For the past century, the long-term inflation rate is about 3 %. It has been slightly higher than that since World War II.
THE STOCK MARKET
If we add up productivity growth, plus current earnings and inflation, we come up with a long-term return of the stock market of 10.5%. It is not quite as simple as this, but I hope it illustrates the point, that until human nature or the human condition changes radically, the stock market will continue to act as it always has.
This is why I say that the stock market is a reflection of the human condition.
While we have many ups and downs in the stock market, over long periods of time, it has always gone up a rate in the neighborhood of 10%. There have been decades when the stock market returns have been negative. There have been decades when returns have been extraordinary. But the returns always seem to gravitate to a mean return in the neighborhood of 10%. Positive stock market returns are never guaranteed. But as our time frame lengthens, particularly when it is more than 20 years, the chances get better and better that human nature wins out over short-term blips, like war, hyper-inflation, mortgage crises and Internet busts.
The after-market for mortgages (Collateralized Debt Obligations) has grown so large and complex that it has baffled the “experts” and blown away the computer models that predicted the safety of these investments.
We are a long way before computer neural networks can fully understand the range of human emotions. We, as humans cannot, and our computer models are only as good as the programmers.
This said: There is an old investment adage that says, “Buy low and sell high.” With most global markets down well over 20%, and the U.S. market faring little better, it is beginning to look more like a time to buy than a time to sell. Does this mean that there is little risk? Heck no. There is still a lot of risk in the stock market. There is still a lot of risk in the global economy.
Studies show that a good deal of the gain after a bear market occurs in a very brief period of time. We are talking weeks to a few months. For those who have a long-term perspective to their investments, it may be a time to begin to accumulate stocks again.
Do I think the stock market has seen its low point? No, I don’t. I still think that we haven’t seen the worst of the news. It is getting bad. This week, Lehman Brothers cried “No Más.” To have a blue chip investment banking firm (the fourth largest) go under (on the heels of Bear Stearns’s even bigger collapse) is monumental.
This is “blood on the streets,” guys. When we look back to these days twenty years from now, we just might be saying “What a great time to buy that was.”
Please do not take this as an investment recommendation. Talk to your fianancial advisor before making any investment decisions, particularly those that involve the stock market.
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