“Despite its severity, we believe that the slump in stock prices will prove an intermediate movement and not the precursor of a business depression such as would entail prolonged further liquidation…”
Harvard Economic Society November 2, 1929
The average man discovered stocks in the 1990s. At first, he thought he had fallen into the Lost Dutchman mine. But in a few years, the paydirt played itself out. Now, he just digs himself in deeper.
Stocks are down an average of 14% so far this year, and down about 30% from the top. So far, the negative consequences of falling stock prices have been offset by rising house prices and the “house money” effect – the money he was losing was never really his in the first place.
Today’s letter, to be continued on Friday, poses the question: how long will this “house money” continue to shelter people from the storm on Wall Street?
“Not very long,” is our answer. Based on the broadest index, the Wilshire 5000, investors entering the U.S. stock market in mid-1997 are now about even. Five years of stock market sturm und drang have left them where they started. No richer. Maybe a little wiser. Certainly older – five years closer to retirement age.
This last detail may be the decisive one. For, when people approach retirement, something happens to them: they become risk averse. A young man – with 60 years of life expectation – will do the damnedest things. He’ll drink a half bottle of good scotch and drive down a mountain road as if he thought he was making a moonshine run. Or, he’ll jump out of perfectly good airplane…Or enlist in the army just when war has been announced.
An older man has few years to lose, but like a shipwrecked sailor down to his last pack of cigarettes, he guards them carefully. He won’t cross against the light…and won’t even have a cup of coffee before going to bed for fear it will disturb his sleep…
Imagine what happens to an economy when millions of people grow old at the same time, dear reader. Well, you don’t have to imagine. You have only to look at what has happened in Japan since 1989…or wait to see what happens in America in the years ahead.
“It amazes me that most people miss the appalling demographics in the Western World,” writes a poster to the Richard Russell website. “This is the thing that keeps me awake at night. By the time a 31 year old retires at 60, almost 50% of the population of the western world and Japan will have retired before him…that is staggering. It should be a long way off but I’m afraid it’s not. The average American is 44 years old, has $40,000 in his 401K and has more debt than at any time in history. He has effectively 10 to 15 years to save enough money to retire. If he wants a retirement income of 2/3rds of his salary then he needs to save something like $500,000 over the next 15 years. I’m not quite sure how he’ll do it.”
How will he do it?
“He’ll either have to retire poor or live like a pauper over the next 15 years. Either way, it’s not inflationary by any stretch of the imagination,” he concludes.
Biology and actuary science converge at around 50 years of age. They soften up a man’s brain and his stomach…and turn him from a dynamic risk-taker into a fretful old coot who won’t part with a penny without a court order.
A man over 50 doesn’t want to wait a quarter of a century for stocks to come back to where he bought them. Rather than take the chance, he typically shifts his portfolio from capital gains to income. His risk tolerance also shifts, from return on investment to return of investment…and his savings strategy drifts too, from just-in-time to just-in-case.
Of course, everything important happens at the margin, as the economists say. The marginal grumpy old man of the ’90s entered the stock market along with everyone else. Who could resist such a party? So, along he came – dressed for a funeral but hoping for a good time.
If he got into stocks in 1997, his portfolio is now worth about what it was when he bought the stocks. But in the meantime, his debts increased, his savings went down, and the cost of living rose 12% over the past 5 years. So, he’s in much worse shape than the Dow suggests.
“Saving short and overly indebted, the aging American consumer is also closer to retirement, on average, than at any point in the post-World War II era,” writes Stephen Roach. “Moreover, with pension fund regimes having shifted increasingly from defined benefit to defined contribution schemes – assets in DC plans first exceeded those of DB plans back in 1997 – the nest egg now looks more precarious than ever. In addition, the equity culture has become more essential than ever to American households in achieving their life-cycle saving objectives. As President Bush indicated in his 9 July speech on corporate responsibility, more than 80 million Americans now own stocks – either directly, in mutual funds, or through their pension plans.”
Monday’s near-panic on Wall Street could be a sign of things to come. For up until very recently, the average aging patsy felt as though he was playing with “house money”. If he had bought before ’97 he was still ahead of the game. It wasn’t his money he was losing, he could tell himself, it was the casino’s money.
Even if he had been holding the big tech – such as Intel, Dell, and Cisco – his positions were still in the black, even after going down 50% to 80% from their highs. But now, the average investor has run out of “house money.”
“American households are now hurting big time,” says Roach.
“The American consumer remains at the top of my worry list in this post-bubble era. The reason – the perils of what I have called the ‘asymmetrical wealth effect.’ This rests on the basic precepts of behavioral finance set forth over 30 years ago by Amos Tversky, a renowned Stanford University psychologist. Through experimental sampling of investor responses to hypothetical and actual financial market situations, Tversky found that the loss aversion motive of individual investors made them far more sensitive to reductions in wealth than to increases in their portfolios. The caveat came in what Tversky called ‘prospect theory’ – that investor responses are also influenced by recent performance. Individuals that only lose ‘house money’ are less inclined to alter their fundamental economic behavior. Conversely, once the accumulation of losses taps into original investor principal, it’s a different matter altogether.”
Historical, real returns on U.S. stocks have averaged about 7% per year for the last 200 years. In the mid- to late-90s, investors got used to returns of 20% per year…and more. Now they are five years older…closing in on retirement age…and taking losses – and not just of “house money,” but of real money, savings that were intended to cosset gray heads and wrinkled brows.
That these marginal, 50-something investors will panic out of stocks seems a foregone conclusion. Will they panic out of houses too…and out of habit of consumption?
“It is in this broader context that I believe that five years of real wealth destruction have the clear potential to trigger the powerful loss aversion responses first envisioned by Amos Tversky,” Roach explains. “Given the demographic profile of an aging American population, saving imperatives are all the more important. That means American consumers now need to save the old-fashioned way – out of their paychecks.”
When Americans begin saving like the Japanese, should it surprise us if the U.S. economy turns a little Japanese too?
More on Friday…
Your roving reporter, in Milan…
July 17, 2002
“The fundamentals are in place for a return to sustained healthy growth,” Greenspan told Congress. Following the testimony, journalists and analysts trying to read the tea leaves were reasonably certain the Fed will not raise rates.
Mostly, “the Fed Chairman came out in favor of trust and against greed,” wrote Rob Peebles at the Prudent Bear.
The creatively ambiguous Greenspan suggested to senators that “even a small increase in the likelihood of large, possibly criminal penalties for egregious behavior of CEOs can have profoundly important effects” on corporate behavior.
The fact that his audience routinely ignore laws requiring their own financial accountability seemed to have escaped the Chairman’s attention.
A recent report suggests that for the past five years the GAO have been “prevented from being able to provide Congress and American citizens an opinion as to whether the consolidated financial statements [of the US Government] are fairly stated in conformity with US generally accepted accounting principles.”
“Over the past five years,” says Tom Schatz, president of Citizens Against Government Waste, “lawmakers have spent a total of $142 billion” more than their budgets allowed. “That’s more than 12 times the misstated figures from Enron, Xerox and Worldcom combined.”
Further, Easy Al’s first comments on the economy in three months did little to boost confidence…the dollar dropped another 1% against the euro. “Foreign investors may be saying adios to the US marts,” says a headline in the NY Post.
“The current-account deficit [likely $35.3 billion in May] and the drying up of investment into the U.S. are much bigger forces than Greenspan,” Stewart Cowley, who oversees $29 billion at Mellon Newton Investment Management, told Bloomberg. “The U.S. is now one among many investment opportunities.”
Have foreign investors finally given up on US markets? If not, maybe these stats will help them make up their minds: Michael Belkin, an analyst with whom we’ve worked on occasion, calculates that the S&P 500 could decline another 50% or so before it reaches a “fair value” in relation to corporate profits. Or known corporate profits.
And since this year’s peak, the Dow has already shed 2,162 points. The Dow industrials, says John Crudele in the NY Post, would have to fall another 3,400 points just to reach their historical average.
Yesterday, as Eric reports below, the Dow closed at 8,639… Eric?
Eric Fry in New York…
– Another down day for stocks. The market is fresh out of miracle comebacks and Alan Greenspan is no help whatsoever. He tried to jawbone the market higher yesterday with a smattering of upbeat economic pronouncements, but his optimistic Fed-speak fell on deaf ears.
– The Dow plummeted 166 points to 8,473, while the Nasdaq fell 7 to 1,375. The Dow has now lost nearly 1,000 points over seven straight losing sessions. It gets worse…After the closing bell yesterday, Intel announced quarterly earnings that were well below what most analysts had predicted (no surprise there…except to the analysts).
– Along with its dismal earnings report, the semiconductor company announced that it would lay off about 4,000 employees. “We were expecting to see an economic recovery in our business, and right now, we see no signs of it,” said CFO Andy Bryant.
– The dollar also fell again yesterday – losing nearly 1% against the euro. [Soon, the boys in Paris will need a raise just to maintain their lifestyle.]
– Side-by-side, on the front page of last Sunday’s New York Times, were two separate stories of human suffering. One story depicted the agony that American investors are suffering as a result of their stock market losses. The other story described how arsenic- laced groundwater in Bangladesh is killing hundreds of thousands of people…
– Which group of folks ought to evoke our greatest sympathy? Those whose self-inflicted acts of naivetundefined or greed caused them to lose money they were lucky to have had in the first place? Or those people who are dying of arsenic-induced cancers because they don’t want to die of thirst?
– Losing money is no fun…but at least it’s not as bad as drinking arsenic.
– Why didn’t more investors sell when they had the chance? The answer is that most investors never thought about selling any stocks at all, except to buy a different one. The stock market was going to go up about 25% per year every year – everyone knew that – and there was simply no good reason to believe otherwise, or so they had come to believe.
– As a professional short-seller throughout the 1990s, I observed over and over again that the one thing absolutely no one wanted was a reason to sell stocks. The overwhelming majority of people I encountered had zero interest in considering what could go wrong or in acting to preserve a portion of their capital. Most of my conversations lasted about one minute: The folks I talked to were bullish, they knew they were right to be bullish (and that I was wrong to advocate a slightly more cautious approach), and after all, they were invested for the long-term, so a little sell-off wouldn’t bother them anyway…Heck, they might even buy more! I would shrug my shoulders and say, “OK, I hope you’re right.”
– I didn’t know then and I don’t know now where stocks are headed next. But I do know that paying $50 for $1 dollar of earnings is usually a bad idea. No matter whether stocks are in a bear market or a bull market, the golden rule of investing never changes; it is, and always has been, buy low, sell high. It is not, “Buy high, sell higher.” Nor is it, “Buy high, because the stock used to be even higher, so it might go back up.”
– Buying richly priced stocks is no different then running red lights – an accident will occur…only the timing is uncertain. As long as the driver manages to avoid a crash, there’s no faster way to get from point “A” to point “B” than to zoom straight through every red light. And in a rip-snortin’ bull market, there’s no faster way to make a buck than to buy the overpriced, speculative stocks that have already been going up for a while. In a bear market however, fatal collisions occur regularly.
– Throughout the late 1990s, many investors ran red lights as they sped toward capital gains faster than their cautious counterparts. Very few of the investors who scorned caution managed to make it through the last two years without a serious mishap. Indeed, many of them now find themselves wrapped around a telephone pole…financially speaking.
– The stock market can be a dangerous place…Drive defensively.
Back in Paris…
*** Still, Americans spent money in May like there was no tomorrow…which, given the dollar’s current direction, may be an accurate observation. “Installment debt” increased by $9.5 billion, bringing the new total to $1.7 trillion. “Personal income” in the US, by comparison, is now less than $9 trillion.
The Mogambo Guru does the math for us: “Citizens owe, if we permit ourselves to merely divide one by the other, 19% of personal income, and their income per person is thus $33,000.
“Oops! Did we forget to subtract taxes from personal income? Well, tax collection averages out to about 24% of income. So income ain’t no stinking nine trillion. After tax, it’s only $6.8 trillion. Bummer. Now, using these much different numbers, that $1.7 trillion in consumer installment debt is now a full 25% of income. (Insert comical animation of eyes bugging from head and hat jumping into air).
“In 1992, a mere decade ago, consumer installment debt was $725 billion. A trillion dollars more debt, in ten years. Of course, nominal incomes are about 30% higher, but is that enough to justify a trillion dollars more debt in YOUR mind? Whew!
“Bravely continuing on in the Swamp of Debt, we note that outstanding private sector debt is now, you’d better sit down for this one, $32 trillion. And who is on line to pay each and every penny of that $32 trillion? The final consumer. You and me. The same lousy 270 million of us.
“So, armed with this data, I confidently fire up the old calculator, having just done so at the beginning of the paragraph, and cipher thusly: $32 trillion plus $6 trillion in government debt equals, wait a minute here, I’ve almost got it, equals $104,640.00 per man, woman and child in the USA. This means that a household of a man, a woman, and even one-point-two kids has per capita debt of almost a third of a million bucks from the get- go! Blam! It’s outta there! A new record!”
p.s. Bill checks in from the road…below…