Dear Stock Broker,
Thank you very much for the recent financial best seller written by Harry Dent and entitled The Roaring 2000’s. The thesis of this book is that the Dow Jones Industrial Average will go to twenty thousand to thirty thousand by 2009, primarily because of the spending habits of the baby boomers. The book points out that there is a “spending bubble” of twenty five years from the end of the 1980’s to 2009, represented by the baby boomers. It assumes that the baby boomers spending habits are like any other normal family’s historical spending habits and that spending will peak for “boomers” for the 25 years up to 2009. It will then recede when the last of the baby boomers expenses of raising children dissipate. Since two thirds of our economy is driven by consumer spending, and since the bulk of family spending is up to when the parent’s children are leaving the home, the theory definitely has merit both in terms of practicality and in terms of probability.
One must look aschance at the theory that the market will obtain at least twenty thousand points in value, however, and probably thirty thousand, because the market is ultimately not based upon consumption, but rather, it is based upon value.
We must also be aware, in our mode of completely dispassionate thinking that your employers, the big stock brokerage houses, know better than anybody that values are out of proportion with historical reality. We must realize that the wealth created from stock transactions in the last fifteen years far surpasses the build up of wealth during the periods of the great robber barons at the end of last century, during the market expansion in the 1920’s, and during the twenty years after World War II.
The later statement is not meant to take a poke at the stock houses. Their orientation must be towards optimism regarding the market. After all, if they were not optimistic, they could not drive those big houses forward into the growth that has been enjoyed over the last fifteen years. Similarly, the optimism that is required by management for these stock houses to succeed can also be a trap that mentally blocks their ability to match reality with history, a balance whose fulcrum may sometimes seem off center, but which in the long run always comes back to center.
Let’s look at a few examples matching reality with history:
The Dow Jones “average” in 1989 was 2510. Today’s market, ten years later, is more than four times the average of just ten years ago. Those investors lucky enough to be in the market over this period of time have done very well.
During the last ten years while the market has more than quadrupled in value, the GDP has gone up by less than 50%. The last time the market quadrupled in value was from 1959 to 1989, thirty years, during which time the GDP increased more than 10 times!
The total market value of America Online, Amazon.com, Ebay and Yahoo Inc. exceeds $200 billion dollars. The earnings of those four stocks combined over the last twelve months have been less than a total of $4 million dollars. None of those companies is ten years old. The total market value of General Motors, Phillip Morris, Proctor & Gamble and Dupont, all leaders in their industry, is equal to the four Internet stocks mentioned above. But the total earnings of these great old line companies the last twelve months has exceeded $18 billion dollars.
The above indicates a value system out of proportion with reality.
Here are some more defining statistics, which further mitigate
caution in dealing with the stock market at these levels:
This market, by every known measure of value, is more expensive than any other stock market in history, including the peaks of 1929.
The dividend yield on the Dow Jones Industrial Average is 1.5%. The historical average is 4.4%, and here-to-four, 3% has been an “indication of danger”.
The Dow Jones price earnings ratio is 26-1. A “Dow Theory” over valued market is 21-1 historically. The average Dow historical price earnings ratio is 13-1.
The price of stocks to their book value (stockholder’s equity) is 6.5 to 1. 2 to 1 has been considered to be dangerously high over the years.
The “breath” of the stock market has been declining for a year. General Electric, IBM, Exxon and a few other stocks are holding the Dow Jones up while most stocks are going down in value. If the declines exceed the advances and new lows exceed new highs, as has been happening for many months, it is because earnings outlooks are decreasing. That is what is happening. If earnings are unfavorably affected in the majority of companies, that same thing must ultimately happen to the bell weather stocks, which stocks are currently holding the market up.
Treasury bills, not a really exciting investment, yield more than 4 times the average yield on the Dow Jones stocks.
Consumer debt and government debts are at all time record highs. If the earnings degeneration in major companies continues, people will be laid off, thereby reducing consumer spending which is what this whole market (and the book’s thesis) is built upon. If consumer spending decreases, and if people are laid off, income is going to go down and people will have a hard time meeting the obligations on their debt. Finance companies and banks will call loans and attach assets. That will substantially reduce government tax revenues, which will put pressure on the government’s budget because interest payments a year now reach almost $400 billion dollars!
While I would not argue with you or the author that the market in 2009 could be 20,000 to 30,000, I would suggest that it would be so extraordinarily unusual and so risky that I would not want to be a participant. You have told me that I am “missing the market” and that it will cost me a lot of money. That may be true, but that is not my point. My point is this: in life we must measure our greed and be thankful for what we have. Under these circumstances, to assume that while we may double or even triple our money over the next ten years, when we have already quadrupled our money over the last ten years, is a risk that most intelligent people would not take; particularly if it’s not supported by concomitant corporate earnings growth, which it’s not. Ultimately the market looks at value. Value in stocks has been measured in how much the stocks pay, which is the dividend or the yield. If the Dow Jones didn’t go anywhere for 4 years the investor would receive a total of 6% by holding a basket of Dow Jones stocks. On the other hand, if an investor held measly old treasury bonds, over the same 4 years they would receive a 25% return on their investment. Four year T-bills will return all principal. If the market recedes only 6% during that time, a stock investment would receive a yield of nothing!
You do the math. To my way of thinking we are in a bubble created by the Federal Reserve System, the media and Wall Street. All bubbles ultimately deflate. The value of all stocks listed on the New York Stock Exchange is $10.6 trillion. Our assets in America are estimated to be $25 trillion. If the New York Stock Exchange was to return to historical average value, the market would be exactly ? of what it is today, or $5 trillion, thereby reducing our estimated wealth in this country by 20% to $20 trillion. I believe many people are “counting” on this wealth and a reduction of stocks to “normal” levels might have a catastrophic effect upon our economy and the world economy. Further, the Dow Jones transports and the utilities are hitting new lows weekly!
So, while I thank you for your ideas, prudence dictates that I stay in cash and treasury bonds, that I measure my greed, that I be thankful for the money made over the last ten years, that I avoid unnecessary stress, which would be driven by greed, and that I sleep well at night.
Best wishes.
George W. Rauch
September 27, 1999
