Stock Market Lessons from Elvis' InfancyChris Farrell
The Presidential honeymoon is over. A bitter election fight looms. Business is dismayed at the Administration's regulatory initiatives and critical words for Corporate America. Sure, the President can and should take credit for containing the economic crisis. Yet his Administration has since been bad for business and the economy.
A prominent business publication sums up where Wall Street thinks the Administration has messed up:
Vacillating and uncertain monetary policy
Intrusion of government into every aspect of business
Maintenance of a "motley crew of amateur advisors and consultants"
Persecution of utilities and financial markets
Hasty adoption of a "stupendous" social security program certain to promote insecurity
Unceasing derogation of business
Believe it or not, that list wasn't directed at the Obama White House by The Wall Street Journal's editors in 2010. No, the target was President Franklin Roosevelt and the negative comments were compiled by the Magazine of Wall Street in 1935. (For eagle-eyed readers, the clue should have been the reference to the electric utility industry, which in the early decades of the 20th century amounted to a far larger proportion of U.S. industrial output.)
Government Debt Stymies Job Growth
Republicans didn't want to work with Roosevelt as the election of 1936 impended. The stunning post-crash stock market rally of 1933, in which the Dow Jones industrial average climbed 54 percent, was long over. Many business leaders felt that Roosevelt's "advance toward socialism by indirection" had to be stopped. The government's deficit financing was unpopular.
"The more the government runs into debt, the less willing is private capital to enter normal long-term employment," complained the editors at the Magazine of Wall Street.
By now many parallels between 1935, the year of Elvis Presley's birth, and 2010 should be apparent. Here's the rub: Investors enjoyed a strong stock market rally in 1935, with the market up by nearly 48 percent. The Great Depression continued and unemployment remained high, but the outlook for both were improving.
"Unlike the editorial writers, investors appeared little concerned about mounting antagonism between government and business during 1935," writes Martin S. Fridson in It Was a Very Good Year: Extraordinary Moments in Stock Market History (my source of information about the 1935 market). "Instead, they took heart from strong indications of an economic rebound."
Is the Pessimistic Posse Dead Wrong?
According to the Journal, sober citizens made up their minds that a normal and natural recovery would occur, "with the New Deal or against the New Deal or without the New Deal."
History doesn't repeat itself, but it can offer intriguing lessons. One message is that it pays for investors to listen less to the pessimistic posse dominating the corridors of power from Wall Street to Capitol Hill and more to the direction of company cash flow and earnings.
Another lesson is that it's risky to play it safe for too long in the markets. Bond yields in 1935 reached their lowest levels since the beginning of the century (another parallel with the age of Bill Gross) and investors eventually shifted their investment focus to stocks.
Will the same thing happen in 2010? The stock market is essentially flat for the year, with the Standard & Poor's 500-stock index showing a total return of only 1.8 percent. The timing of any rally is uncertain, of course. A pall hangs over the stock market, yet the list of positives is compelling.
Cash and Profits Are Soaring
The economy continues to expand, albeit slowly, while U.S. companies with a global presence earn revenues and profits wherever opportunities lie. Corporate merger-and-acquisition activity is picking up, with nearly $500 billion in deals year-to-date, including such marquee takeovers as Intel's (INTC) $7.68 billion purchase of McAfee, Hewlett-Packard's (HP) nearly $4 billion spending spree for ArcSight and 3Par, and Hertz's (HTZ) $1.4 billion acquisition of Dollar Thrifty. Over the same time period, there have been 176 positive dividend announcements by S&P 500 companies this year, and only three dividend reductions, according to the rating agency Standard & Poor's (MHP). That compares with 157 positive moves and 78 reductions for all of last year.
Cash and its equivalents for the S&P industrials are up seven quarters in a row, to an unprecedented $842.4 billion. The aggregate holdings represent 11.13 percent of current market value and five times the annual dividend payment, calculates Howard Silverblatt, senior index analyst at Standard & Poor's. Quarterly profits are up 52 percent from a year earlier.
"The cheapest place in the U.S. is large capitalization growth stocks," says Ross Levin, a certified financial planner and president of Accredited Investors. "The balance sheets are terrific."
At the same time, to anyone investing for the long haul, say, in a 401(k) plan or a 529 college savings plan, the general message is that bonds are diamonds in the performance sweepstakes while stocks are cubic zirconium. A major factor behind the stellar performance of bonds is a flight to safety from economic turmoil. But bonds have also done well over the long haul. For instance, from 2000 through 2010, U.S. Treasury bonds have sported an average annual return of 7.69 percent, vs. a –0.95 percent return for stocks, according to Ibbotson Associates, a Morningstar (MORN) company. The MSCI World Index of developed markets has fallen by 27 percent since 2000 while the JPMorgan global bond index has soared 80 percent, according to Bloomberg.
FDR's Real Mistake: Early Budget Cuts
But with yields on Treasuries hovering near record-low levels, the low-hanging fruit in fixed income may have been snatched up. The same isn't true for stocks. For example, the S&P 500 currently sells at about 13 times one-year-forward mean estimated earnings per share, says James W. Paulsen, chief investment strategist at Wells Capital Management. The 10-year Treasury bond yield currently sells at around 33 times its annual coupon payment. Should the economy and job creation continue to expand, "a stock market at 13 times earnings and a 10-year Treasury bond yield at 3 percent will look pretty silly in a world characterized by solid outperforming earnings growth, record-low interest rates, and a less-than-1-percent core-consumer-price inflation rate," says Paulsen. (See "Back to the Future for Dividend and Bond Yields.")
By the way, there's a final lesson to take away from 1935. Deficit financing and monetary easing are far from the evils they are made out to be by advocates of fiscal and monetary austerity—at least not when demand is weak and unemployment high. What helped bring the stock market and the economy down in 1937 was a too-early embrace of fiscal rectitude by President Roosevelt and a tightening by the Federal Reserve.
Still, despite heated political rhetoric about fiscal austerity and grumblings about easy money from the hard-money crowd, it's unlikely that the mistake of 1937 will be repeated. The Obama Administration and Republicans are currently competing to come up with tax cuts for business and workers. It's likely some sort of tax break—another sort of fiscal stimulus—will be passed over the next several months. Fed Chairman Ben Bernanke, a premier scholar of the Great Depression and its aftermath when he was an academic, has made it clear in recent speeches and in congressional testimony that the central bank has no intention of tightening with the unemployment rate at 9.6 percent.
With any luck, it's 1935 that repeats itself—not 1937.