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.”
When he continued, the professor seemed to have the Daily Reckoning in his sights: “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 31, a year later] – 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…
The Intelligent Multitude: Folderol
But in large groups of people, complex and even elegant ideas get mushed down into 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.
The Intelligent Multitude: Traditions Beaten into Shape
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…Light-headed, 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.'”
The Intelligent Multitude: Flooding the US with Money
“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 [$31, a year later] as the right price.
Today, the judgment of the multitudes is that GE is a decent deal at $30 and Microsoft, at $51 [a whopping $25 today], is fairly priced. Tomorrow, they may think differently.
Your tradition-minded correspondent…
June 12, 2003
The subject was bonds…
Yesterday, we offered a coward’s guess…that people buying up U.S. Treasury bonds at the highest prices since Eisenhower was president would find them less safe than they imagined.
We did not say when…
Today, we stick our necks out on the when question: not yet. And we have more to say about why.
After a mighty exertion in WWII and Korea, the U.S. went back to business in the 1950s. A creditor to the entire world…with domestic savings rates near 10%, productivity rising, a conservative administration in Washington and young, new families spilling out of every Chevrolet and Ford, America could rightly expect to pay little interest when it borrowed money; there was no better credit risk in the entire world. Even so, U.S. Treasury bonds proved poor investments. After Eisenhower came Kennedy. And after low yields came higher ones.
Even if you put a golf club in George W. Bush’s hands, he would hardly be mistaken for Dwight D. Eisenhower. Nor would replaying old Hank Williams or Patsy Cline favorites put us in the mood to buy the debt of the nation that has become the world’s greatest debtor. For in the space of half a century, the U.S. has changed remarkably. Instead of paying its debts, it adds to them. Instead of tending to its own business, it minds everyone else’s. Instead of protecting its currency, its central bankers try to destroy it.
While the U.S. economy barely moves, for example, its debts, obligations, and money supply run wild. In the week ended on May 28th, another $8.7 billion of new credits screamed out of the Fed. The Fed’s assets have been growing about 6 times as fast as the nation’s supply of goods and services. And even if, despite the central bank’s best efforts, the U.S. dollar should ever manage to hold its value, or – God forbid – go up in value, economists at the Fed assure us that they have ways of bringing it back down. If need be, “the Fed would pursue a targeted, substantial depreciation of the U.S. dollar, by purchasing foreign currency using newly minted dollars,” say a pair of them in Dallas. [Ed note: For more on where the dollar is headed, see the following report from our friends in the research wing of Everbank: “The Decline of the Dollar“]
Still, we do not predict an imminent collapse of bond prices. We have a sneaky feeling that Eisuke Sakakibara is right; that maintaining modest rates of inflation will be harder for the Fed than it thinks. Mr. Market will play with his mouse before killing it…
Our colleague, Eric Fry, from New York…
Eric Fry on Wall Street…
– Stocks soared again yesterday as the Dow, Nasdaq and S&P 500 all hit fresh one-year highs. The Dow rose 128 points to 9,183, while the Nasdaq gained 1.1% to 1,646. Lucky for investors, the stock market requires no evidence of economic recovery to continue soaring higher. Instead, it relies upon the combustible mixture of hope and hype to power its advance.
– “This Mini-Boom is Doomed to Fail,” Comstock Partners asserts. “Almost every meaningful economic number has shown continued weakness…Even so the stock market has climbed significantly as investors, for the third straight year, are placing their faith on the hopes of a strong economic recovery on the basis of very little evidence…We believe this ‘mini bubble’ will burst soon.”
– Among the many goads that are lying in wait to puncture the mini-bubble is the nation’s large and growing debt load. Debt-cultivating is the newest national pastime, and everyone is joining in the fun, especially Uncle Sam.
– “The Congressional Budget Office now expects this year’s federal deficit to exceed $400 billion,” the Associated Press reports, “shattering the previous record even as President Bush and lawmakers consider creating expensive new prescription drug benefits for Medicare recipients. Only a month ago, the budget office – which is Congress’ top nonpartisan fiscal analyst – said for the first time that it believed this year’s shortfall would exceed $300 billion…This year will mark the second consecutive one with a budget deficit, following four straight annual surpluses in the second term of the Clinton administration.” – Should we be surprised if the deficit soars to more than $500 billion before the year is out? For perspective, the largest budget gap ever was the $290 billion in red ink produced in 1992…We cannot say for certain that the swelling government deficit is bearish, but we would guess that it is not bullish.
– The nettlesome corporate pension plan crisis is another item that we’d put in the “not bullish” category. According to a new study by FTI Consulting, the S&P 500 companies will have to kick in about $36 billion to their pension plans over the next 16 months…and that’s just the base amount needed to top off the plans to their minimum funding levels…Out of 354 S&P 500 corporations offering defined- benefit pensions, 215 will likely need to make added contributions in the next 16 months, predicts FTI.
– 19 of the S&P 500 companies are in particularly bad shape, pension-wise, in that they must devote more than 30% of their most recent fiscal year’s free-cash flow to shoring up their pension plans…It ain’t easy growing earnings when retirees are skimming 30 cents off of each and every dollar of profit.
– “Where will the companies get the cash?” the Associate Press wonders. “Not from current resources or operations, since the study singled out companies that don’t have them…The companies…might need to divert funds from reinvestments or shareholder distributions, or draw on bank lines of credit.”
– Think ‘underfunded pension’ and it is difficult NOT to think of General Motors, the pension-underfunding poster child. Tuesday, the struggling automaker admitted that falling bond rates had added $6bn-$8bn to its retirement liabilities, just as we predicted in this column a few weeks back.
– “The expanding hole in the U.S. carmaker’s pension fund, which reached $25bn at the end of last year, increases the problems for the company as it struggles with a fierce domestic price war,” the Financial Times notes. Yet, miraculously, GM shares have been climbing higher lately…Hope blended with hype is a powerful fuel for the stock market.
Meanwhile, back in Waterford, Ireland…
*** “What? Your wife didn’t feed you…”
Taking a cab to the airport, we found ourselves in the company of driver who liked to talk. Cabbies must all have time to think, but few share their thoughts so readily.
“You know, a woman who doesn’t cook is only half a woman. Here’s what to d get a mistress. Then, your wife will take care of you properly. They need the competition…”
“Wouldn’t it be a lot simpler to go out to a restaurant?” your editor asked.
“Well, maybe, but not as much fun. Besides, if you take the easy way out, your wife will never learn to be a good wife…”
He had a point. A man should think of what is good for his wife, not necessarily what is good for him.