AFTER MORE than a decade of poor returns, the print media has turned decidedly bearish on the stock market. The front page of USA Today on May 7th, for example, contained a centre column with the gloomy headline, “Invest in stocks? FORGET ABOUT IT”.
The column’s opening left the reader under no illusion as to its downbeat view on equity investing. It read: “On Main Street these days, investing in the stock market is about as popular as watching a scary movie on a 12-inch black-and-white TV. Wall Street’s long-running story about how stocks are the best way to build wealth seems tired, dated and less believable to many individual investors.”
USA Today is not alone in its sceptical views on the merits of equity investing, as similarly themed pieces have featured across the entire spectrum of the print media, including the Financial Times. Not to worry, say the bull market cheerleaders, who believe such commentary is an important contrarian indicator that could well spell better times for equity investors in the months and years ahead.
The bullish interpretation appears to stem from the infamous Business Week cover story, “The Death of Equities”, of August 13th, 1979, which concluded with the lines: “Today, the old attitude of buying solid stocks as a cornerstone for one’s life savings and retirement has simply disappeared. Says a young US executive: ‘Have you been to an American stockholders’ meeting lately? They’re all old fogies. The stock market is just not where the action’s at.’ ”
According to the uber-bulls, the article’s publication coincided with an important inflection point in the equity market’s fortunes. They say it marked the end of a prolonged period of poor stock market returns that began in the mid- to late-1960s and the birth of an extended upward trend in the major market averages that persisted until the summer of 2000.
The perennial optimists are undoubtedly correct in their assertion that the negative opinions expressed in newspaper stories, both in the late-1970s and now, are remarkably similar. However, the ultimate conclusion that this is an unequivocal bullish development is premised on myth and wishful thinking rather than sound analysis; the bullish interpretation is simply not supported by historical fact.
Turn back the clock to August 13th, 1979, and the SP 500 closed at 107 – a level it first reached more than a decade earlier in 1968. Adjusted for inflation, the market average’s performance was far more disturbing, with the price index giving up all the capital gains since the summer of 1955 – a dismal run that pushed valuations to generational lows of just eight times trend earnings.
Despite the compelling valuation, equity investors were still not out of the woods, as the appointment of Paul Volcker to the helm of the Federal Reserve one week prior to the article’s publication was accompanied by a radical change in monetary policy designed to bring an end to the era’s runaway inflation. The new direction for Fed policy was issued on Saturday evening, October 6th, 1979, when the discount rate was raised by a full percentage point to 12 per cent, and other special measures were implemented to rein in the money supply.
The Volcker Fed’s appropriately named “Saturday Night Massacre” triggered an immediate response from financial markets: the major stock market averages registered a six percentage point decline in the following trading week, while the yield offered on 10-year Treasuries jumped above 10 per cent for the first time. Further weakness was to follow as the economy slid into recession, and stock prices fell until the spring of 1980.
The Saturday Night Massacre was only the beginning of the Fed chairman’s anti-inflation crusade. Following a brief lull during the 1980 downturn, Volcker began to tighten interest rates even more. Ten-year yields soared to more than 15 per cent during the autumn of 1981, while stock prices entered a steep decline as the economy suffered its deepest recession since the 1930s.
Almost three years after the publication of that Business Week article, the stock market finally hit bottom on August 12th, 1982. In the intervening years, investors in the SP 500 appeared to suffer only a relatively modest decline as the index dropped from 107 to 102. However, the elevated inflation rates at the time meant the erosion of purchasing power was far more serious. Indeed, the capital loss in real terms approached 30 per cent as the inflation-adjusted price index revisited levels first seen more than eight decades earlier, during the spring of 1901.
Uber-bullish investment strategists are salivating at the prospects of solid multi-year stock market gains after publication of several articles in the print media that are eerily similar to the Business Week one from 1979. However, the positive spin demonstrates not only a complete lack of knowledge of the period in question but also fails to mention that the price multiple on trend earnings is more than 10 points higher today.
Should investors act on the advice of such perennial optimists? FORGET ABOUT IT.
