Q&A: Still a True Believer in Dow 36,000 (extended)

Co-author Kevin Hassett says values will soar yet

Kevin A. Hassett and co-author James K. Glassman startled the financial world with their 1999 book, Dow 36,000. It argued that as investors grew comfortable owning stocks, stocks became less risky, and that once the market adjusted to that lower risk, stocks would be revalued much higher.

BusinessWeek Senior Writer Robert Barker recently spoke with Hassett, a resident scholar at the American Enterprise Institute in Washington, D.C., on how he sees Dow 36,000 in light of a nasty bear market. Hassett also shared his thoughts on investing in the year ahead and previewed his next book, Bubbleology, which is due to be published by Crown Business in May. Here are edited excerpts. Note: This is a longer, online-only version of the interview that appears in the Dec. 31/Jan. 7 issue of BusinessWeek.

Q: Were you guys wrong in your estimate for the Dow's potential?

A: No, I don't think so at all. I think that the stock market moves up and down over time and that no one said the stock market's fluctuations were over once and for all.

The most telling and interesting thing is that at about the time the book came out, we were at Princeton University debating [Yale University professor and noted bear] Bob Shiller and some other stock market experts. The participants in the conference generally agreed that the proper test of who was right would be if, after two years of a weak or flat stock market, individuals stayed in stocks and didn't run for the exits. Then, we would have been proven right. And I would argue that in fact that test has occurred, and we won.

Q: What about readers who bought stocks on your advice?

A: Folks who took the advice of the book extremely seriously benefited tremendously in the last two years. The book is titled Dow 36,000 for a reason. Jim and I looked very carefully at Old Economy stocks that make money and grow it over time, and found that they were significantly undervalued by reasonable valuation metrics.

In the book we listed a bunch of stocks that met those conditions: Johnson & Johnson (JNJ ), General Electric (GE ), Coca-Cola (KO ), Microsoft (MSFT ), Tootsie Roll (TR ), companies like that. We had an assistant go through recently and pick out all of the stocks that we called "36er stocks" in the book and then asked the question, how would you have done if you had bought those as opposed to the S&P 500 and held since the book came out?

Q: And?

A: And the answer is you outperformed the S&P 500 through Oct. 30 this year. From Sept. 1, 1999 through Oct. 30, 2001, we outperformed the index by 20 percentage points. Or 19.43, to be precise. And we significantly outperformed the Nasdaq. And so I think that everything that has intellectual content within the book has sort of broken our way.

Q: Wait, does that the mean the title doesn't have intellectual content? You talked about getting to Dow 36,000 in three to five years.

A: Oh, but we were very, very cautious about making people understand that there were no guarantees in the near term. We also said in the book that the market might drop 30% to 40% in the next couple of years.

Q: Would you adjust the timing of when the Dow might get to 36,000, from three to five years? Now, we have only one to three years to get there from here.

A: No, but I the three-to-five-years thing was never a firm prediction, and I think many reviewers noticed that. The three to five years came from the declining equity premium in the previous four or five years going into when the book came out. If that had continued along the same trajectory, then that's how long it would take to get to 36,000. That's where the number came from.

Q: A central part of the book's argument was that for a long-term investor, stocks actually are less risky than bonds. Have the terrorist attacks and fears altered that relationship, stocks to bonds? Don't the attacks make you more want to own bonds than stocks?

A: I would have to say no. The risks for nominal bonds, the ones that are not inflation-adjusted, are exceptionally high. The fact is that we're nearing the end of a recession, in all likelihood. And there's a tremendous amount of monetary stimulus out there, and fiscal stimulus as well. Normally when that happens, inflation takes off like crazy, and people who own bonds get creamed.

Q: What have you been studying more recently?

A: In the book that I just finished that's coming out in the spring. I basically turned my attention to study the firms that exist in the very ambiguous space that is at the frontier of our economy. And I tried to think about how the market values those.

Q: Does your book have a title?

A: It's Bubbleology: The Remarkable Science of Stock Market Bubbles.

Q: What's its central thesis?

A: There are two types of stocks: Stocks that are safe from bubble forces and stocks that are not. The mission of Bubbleology is to help readers decide what fits into those sets. The book draws on an enormous, burgeoning, and fascinating literature in academic journals that has been produced by not only some of our best economics and finance professors but also people from other fields, including theoretical physics.

Q: Go on.

A: For me personally, the interesting journey of writing this book, the interesting way it has changed my thinking, is that two years ago when I started the project, I was sure that there were never any bubbles and that they never happen. But then after reading for two years, I became convinced that [Bubbleology] is the characterization of the world that you need to rely upon.

Q: Do we have bubble stocks in the market now, or have they all been popped?

A: There may well be, but there are no obvious signs of them right now. But yes, I think that it's quite possible that we do.

Q: Please summarize your advice for individual investors who are thinking of how to allocate their portfolios, stocks vs. bonds, with a long-term view. I gather you feel now even more strongly than before that bonds are a poor choice?

A: Yes, bonds are a poor choice. If you're going to buy them, you should buy Treasury Inflation-Indexed Securities. And be very careful about inflation this year, so think about things that get hurt when inflation takes off and stay away from them. I'm worried that 2002 is going to be a year where you see some pretty big surprises in inflation.

Q: And stocks?

A: For stocks, we've had a run of bad surprises in the economy, and if that stops and we start getting good news...the upside for prices is significant, provided that earnings growth returns. So as positive earnings surprises start to roll in next year, it will be a strong year in the [stock] market.

But, again, I would want to close with the advice from Dow 36,000: I believe very strongly that if you want to benefit from real earnings surprises, then you need to buy stocks that have earnings. So you should be still looking at value funds, if you're buying mutual funds. If you're buying individual stocks, buy blue chips.

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