Professor Joseph Lawrence of Princeton University earnestly declared: "The consensus of the millions of people whose judgments decide the price levels in the stock market tells us that these stocks are not overpriced."
The professor then seemed to have the Daily Reckoning in his sights when he continued: "Who then are these men with such a universal wisdom that it gives them the right to veto the judgment of this intelligent multitude?"
There is little doubt what the intelligent multitude thinks today. Stocks must be worth 41 times earnings – or else investors wouldn’t buy them. Who are we to question the judgment of so many?
Doubting the wisdom of the masses – whether they are voting with their money…or with their ballots – is a regular feature of this space. It is not, we hasten to point out, that we think people are necessarily dumbbells. For we are human too – and prey to all the weaknesses to which flesh is normally heir, and to a few more of our own invention…
But in large groups of people, complex and even elegant ideas get mushed down to a fermenting syrup of empty jingles, slogans, and campaign folderol. From time to time, now and again, but according to no published time- schedule, Mr. John Q. Public takes up the brew and quaffs it like a dipsomaniac with an empty stomach. In practically no time at all – it has gone to his head. Professor Lawrence gave us his opinion. Writing in the summer of 1929, his timing was unfortunate…He was right about what the multitudes thought at the time. But a few months later, the multitudes had changed their minds.
"That enormous profits should have turned into still more colossal losses," wrote Graham and Dodd in their review of the ’29 crash and the aftermath, "that new theories have been developed and later discredited, that unlimited optimism should have been succeeded by the deepest despair are all in strict accord with age-old tradition."
There is nothing wrong with the judgment of the masses; but the hot steel of public opinion needs to be hammered a few times before it is of any use. People make progress in technology, we are fond of pointing out, but in love, politics and markets they go from one myth to the next, pausing at reasonable points of view only long enough to sneer at them.
When they are in a bullish frame of mind, reasonably priced stocks are considered losers – left behind by the New Thing, whatever it is. When they are bearish, reasonably priced stocks seem like bait for fools…for investors are sure that all stocks will go down.
Traditions do not arise in the course of a single generation. What makes them valuable is that they develop little-by-little, wrought by heat and cold, beaten into a serviceable shape by countless pounding over many generations, through many complete cycles.
In the early ’20s, age-old tradition had told investors to watch out for stocks, they were dangerous. In 1921, the great mass of investors judged a dollar’s worth of corporate earnings to be worth only $5 of stock price. But something happened in the late ’20s that changed the stock-buying public’s view. It was a "new era" in the ’20s, complete with a number of important new innovations – the automobile, electrical appliances, radio broadcasting and so on…Lightheaded, by ’29, investors were willing to pay $33 for every dollar of earnings – and still considered it a fair trade. Then, of course, came the crash.
By the end of the end of the year, investors asked themselves: "What ever made me think GE was worth so much?" Mr. John Q. Public never had a clue…then or now. Herewith, we give him a hint:
In the summer of 1927, the world’s central bankers got together – much as they did in Montreal just last week. "[Montagu] Norman [of the Bank of England] and [Benjamin] Strong [of the U.S. Fed] summoned Schact of the Reichsbank and Rist of the Banque de France to a conference at which it was proposed that they all increase credit together…" writes our U.K. correspondent, Sean Corrigan. Then, as now, "the continentals demurred…" So, the Anglo-Saxons acted on their own.
"Strong blithely told Rist," Corrigan continues, "that he was going to administer a ‘little coup de whiskey to the stock market’…Adolph Miller of the FRB subsequently testified to the Senate Banking Committee in 1931 that this episode constituted ‘the greatest and boldest operation ever undertaken by the Federal Reserve System and, in my judgment resulted in one of the most costly errors committed by it or any other banking system in the last 75 years.’"
"Now skip to autumn 1998," urges Corrigan, "when the world economy, still racked by the problems of the Asian debt bust over the preceding year, then had to cope with the Russian default and implosion of the mighty Long- Term Capital Management…Once again, a Fed chairman…flooded the U.S. with money…
"The whole sorry history of the last six years is one of building up huge new swathes of debt on the top of older ones. All the while, we deluded ourselves that the composition of growth stimulated by this and the concomitant rise in asset prices were supportable."
Traditionally, credit bubbles don’t last. Nor do the stock prices they inspire.
At the beginning of the ’80s, you could buy a dollar’s worth of corporate earnings for just $7. At the top, according to Yale Professor Robert Shiller, investors paid $44. Even now, three years into a bear market – the muddled masses judge $41 as the right price.
Today, the judgment of the multitudes is that GE is a decent deal at $30 and Microsoft, at $51, is fairly priced. Tomorrow, they may think differently.
Your tradition-minded correspondent…
June 10, 2002 — Paris, France
"According to the National Association of Realtors," writes my old friend Scott Burns for MSN Money, "the median home resale price in ’91 was $97,100." Ten years later it was worth $147,500. Scott figures the annual 10-yr. compound rate of return at 13.7%.
During the same period, the Vanguard 500 Index Fund would have given you slightly less – 12.1%. But since returns from stock market gains are taxable, whereas returns from your own home are usually tax-free, the house was an even better investment.
More recently, houses have become even better still.
"Over the last 3 years, home equity grew at 20.5%," Scott continues, while "the index fund investment lost 1.5%."
So far this year, the housing industry had 3 of its strongest months ever – January, February and April. So attractive has home ownership become that fewer and fewer Americans can afford to buy one. And nowhere is home ownership more attractive than in California, where the median home has gone up 30% in the last year – to $312,950. This despite the fact that house prices in the Bay Area actually fell 0.4% – with the median down to $482,000!
Should you buy a house now, to get in on the boom before it is too late? We don’t know, but the fact that so many people think the boom is eternal makes us think it may end tomorrow. This may be a good time to rent.
Today, special coverage from our London correspondent, Capital Insight’s Sean Corrigan…
Sean Corrigan, the Daily Reckoning’s eyes and ears in the UK:
– The Dow ended the week down 34 at 8589, while the Nasdaq dropped 19 to 1535. The Nasdaq 100 closed less than 2% above its WTC attack lows.
– ImClone, Tyco, Adelphia, El Paso, and Cendant continue to be under regulatory scrutiny while there were warnings not just from Intel, but from mobile handset component maker RF Micro and from Biotech leader BioGen.
– In case you were wondering, "There is absolutely no housing bubble on a national basis," says David Berson in the Christian Science Monitor.
– Who’s he? Well, vice president and chief economist with the controversial Fannie Mae, the nation’s largest provider of mortgage funds, whose company would pretty much be guaranteed to top any poll asking who was responsible for such a phenomenon.
– Other less-prejudiced analysts are more skeptical. "There are a lot of markets that are in a housing bubble," says Ingo Winzer, president of Local Market Monitor in Wellesley, Mass.
– Mr. Winzer tracks the relationship of income to housing prices in 120 local markets. And right now, he says, 45 percent of them are overpriced – a record.
– "People right now apparently are willing to go into debt more than ever to buy a house and other stuff," he adds. Among his top overpriced markets: Boston, San Diego, Detroit, and Denver.
– One of the numbers we at Capital Insight distill out of the non-farm payroll report is something called the Real Wage Fund. Basically, we take the number of hours worked and multiply it by the hourly rate to give us a basic handle on what people take home – before the taxman, the loan repayments and all the insurance charges take a bite out of it.
– Then we compare this most elementary measure to the gain in the median CPI, to see how much is left after we account for the Fed’s work to undermine the value of the Dollar.
– Want to know something? You can see the pain written all over the numbers.
– In manufacturing, this "real" wage fund has fallen 7.5% for each of the past two years as payrolls have been slashed. Even in services, the fund is effectively unchanged from the start of the Bear Market in September 2000 – a year and a half of stagnation to be compared to average 4.5% gains for the previous four years. – Another disheartening result is that the median period of unemployment (i.e. the time for which half the jobless are out of work) has stretched to a tad under ten weeks – the worst in nearly seven years and only beaten by eight months in the 34 years of data.
– Unless production picks up, householders, with income growth already zero, are soon going to find their credit exhausted, too. Then the fun will really begin.
– However, the prospects for production are not all that bright, if we consider reports that in April, U.S. machine tool demand fell sharply, as the manufacturing sector continued to struggle.
– The American Machine Tool Distributors’ Association (AMTDA) and the Association for Manufacturing Technology (AMT) reported that April machine tool demand totaled $171.36 million, down 8.0% from the prior month, meaning purchases of machine tools – used to shape metal for such products as car engines, refrigerators and television sets – has slumped 15.7% from the same month a year ago, as a depressed economy has slowed demand for these products. – "Manufacturing is still dragging despite some optimistic general economic reports of a near term recovery," Ralph Nappi, president of AMTDA, said in a statement published in Reuter’s. – Nappi said the sector shows little sign of turning around as businesses look overseas for cheaper labor and more favorable manufacturing environments, stunting investment in new equipment domestically.
– This should be interesting – the Queen, still recovering from her Golden Jubilee bash and her supposed newfound approval, has decided to reveal all.
– We the People will be able to see just how she spends her £7.9 million allowance. The Sunday Times reports that the Queen’s household accounts will be published, in much the same way as any other business. We’re sure she’ll turn out to be just as frugal as the best of us (on a much grander scale, of course).
– The British population is still not convinced that joining the Euro is such a good thing and, after last week’s events, it seems we’ve all suddenly become loyal nationals again. With Royalty rubbing shoulders (albeit lightly) with the riffraff during the Jubilee celebrations, the fall from grace of World PM Blair and the success (so far) of the England football team in the World Cup, its no wonder people have become patriotic and faithful to the Pound.
– The No campaign couldn’t have organized it any better. BBC News Online claims that, out of 2000 questioned, 57% don’t want to adopt the Euro and only 21% are in favor. The remaining 22% were still in a haze!
Back in Paris…
*** How much of your money should you have in stocks? Steve Sjuggerud gives us his rule of thumb: "100 minus age is the percentage you should have in stocks…So if you’re 30, you should have 70% of your investible funds in stocks. And if you’re 70, you should have 30% in stocks. This is because stocks are less safe than the alternatives, so the older you get, the less you should have in them." Are stocks really less safe? More on that below…
*** Consumers went into debt more than expected in March…and again in April. They added $8.8 billion to their debts in the latter month…indicating either rising optimism, stupidity…or perhaps both. Widely reported as good news, the BBC noted that "consumer organizations sometimes see it as a sign that people are short of cash…"
*** The world’s only superpower is headed into the world’s only super-recession, we continue to believe – against the weight of opinion and the popular evidence. Consumers are so confident that they are spending themselves into insolvency…and bidding up the prices of housing to the point where they can no longer afford it. Who are we to doubt the wisdom of the great American muddle-class? More on that below, too…
*** Meanwhile, on the other side of the globe, consumers are still reluctant to spend…investors are afraid to invest…and nobody wants to borrow, unless he has an unprofitable business to keep afloat. Yet, "Japan out of recession," claims a BBC headline. "Japanese GDP up at fastest rate in 2 years," adds the Financial Times. Could Japan finally be coming out of its long, soft, slow depression – just when the U.S. economy begins its own?
*** The newspapers are full of the usual nonsense. Here at the Daily Reckoning we collect imbecilic editorials the way some men collect beer cans; we enjoy looking at them even though we can’t quite stomach the contents.
*** Most moronic of late is an editorial by Thomas L. Friedman, in which the N.Y. Times pundit begins hallucinating about "America’s Failure of Imagination." Friedman imagines Bin Laden as "a combination of Charles Manson and Jack Welch" – an evil personality, but with organizational skills. We Americans can’t imagine such evil, says he, of the people who x-rayed my penny loafers twice; "we keep reverting to our natural, naively optimistic selves."
*** Friedman, himself, seems to have a full tank of imagination; he runs low on common sense. Apparently, the 39,000 employees of the National Security Agency are not enough for America’s imagining needs. "We need an ‘Office of Evil,’" he proposes, "whose job would be to constantly sift all intelligence data and imagine what the most twisted mind might be up to."
*** If he had stopped there, his opinions might have gone in our ‘Merely Stupid’ pile. But Friedman is not satisfied with mediocrity…he aims for sublime idiocy and rarely misses his mark. He blames the Bush administration, he says, for "squandering all the positive feeling in America after Sept. 11, particularly among Americans who wanted to be drafted for a great project…"
*** What great project? How about "a Manhattan project for energy independence…a crash effort to produce enough renewal energy efficiencies and domestic production to wean us gradually off oil imports."
*** "We and our kids are going to regret this…," says the opinion-leader.