by Rob Bennett
There have been years when we have seen very high stock returns. We have seen years when stock prices went up by 10 percent or 20 percent or even 30 percent. There also have been years when we have seen very big losses. We have seen 10 percent and 20 percent and 30 percent losses too.
The stock market is a proxy for U.S. productivity. The earnings paid to stock investors are the product of the wealth-generation activities of the companies that comprise the market. In years when we see big stock gains, the companies are generating earnings like crazy. In years when we see big losses, the companies are not generating earnings.
I don’t think that’s right.
The reason why I don’t think that’s right is that we don’t see big differences in long-term returns. For the 30-year time-period from 1940 through 1969, the annualized return was just over 6 percent real. For the 30-year time-period from 1950 through 1979, the annualized return was just under 5 percent real. For the 30-year time-period from 1960 through 1989, the annualized return was again just under 5 percent real. For the 30-year time-period from 1970 through 1999, the annualized return was just over 8 percent. And for the 30-year time=period from 1980 through 2009, the annualized return was 7.4 percent real.
It’s always something in the neighborhood of 6.5 percent real, not too much higher than that and not too much lower than that. There are variations in the 30-year return. But the size of the variations we see in 30-year returns are nothing close to the size of the variations we see in 30-year returns.
If it is good news about corporate earnings that causes gains and bad news about corporate earnings that causes losses, it wouldn’t turn out like that. If it were poor corporate earnings causing poor stock returns, we would not see a bad return in one year of a 30-year time-period always being matched with a good return in another year of the same 30-year time-period, so that the 30-year returns all in the same general neighborhood.
Earning reports are separate events. A bad earnings report is just a bad earnings report. There is nothing in it that should cause earnings in a subsequent year to be good. But stock returns for different years are connected events. Good returns today cause bad returns tomorrow. Bad returns today cause good returns tomorrow.
The proves that earnings reports are not what determine stock returns.
If investor emotion causes stock returns, then we’ve got everything backwards. We note that stock returns are poor in bad economic times and conclude that it is those bad earnings reports that are bringing stock prices down. Once we give up the idea that earnings reports determine stock returns, new possibilities rush to mind.
If investor emotion causes stock returns, it might be that the reason why bad economic times and low stock returns are connected is that investor emotions turn sour when stock returns are poor. When stock prices drop, investors perceive themselves to be poorer. They become afraid to spend. The spending cutback causes businesses to fail and workers to lose their jobs.
We don’t need an economic stimulus. The economic fundamentals are fine. The problem is that investors no longer have confidence in their personal financial futures because they are so far behind where they hoped to be today because of the Lost Decade for stocks. We need to give investors a psychological boost.
But how can we reassure investors? The Fed has been trying to do just that with its QE2 pump-priming and investors seem to be becoming less confident over time rather than more so.
You can’t force an emotion. If someone turns down your invitation for a date and you press, it’s a turnoff. The smarter approach is to accept the realities and perhaps try again later. Investors don’t today respond to attempts to lift their dark mood. They don’t trust good news. Stock prices are going to continue to fall (in a long-term sense) until that fundamental psychological reality changes. The historical data suggests that it will take a 65 percent price drop from today’s levels for that change to take place.
Investor psychology changes at its own pace. There are times when investor psychology changes in accord with what you would expect to see in response to economic changes taking place. And there are times when the two sorts of changes proceed on very different tracks. We need to stop assuming a connection that often does not exist.
It is bull markets that causes investor fears. Bull markets are times of mass delusion and all investors possess a commonsense understanding that mass delusions never end well. So, once a bull market takes place, there is nothing that can be done to stop the souring of investor moods that always follows from a bull and the economic collapse that always follows from a souring of investor moods. The constructive thing to do would be to stop bull markets before they get out of control and thereby avoid the souring of investor moods that causes economic collapses.
Could it really be that ending recessions and depressions could really be that simple?
I think so. If you consider the dollar impact of a fall to fair-value stock prices following a runaway bull, you see that bull markets make economic collapses inevitable. Stocks were overpriced by $12 trillion in January 2000. The strongest economy in the world cannot take a $12 trillion hit and remain standing.
There has never been a time when we have made it a public policy imperative to stop bull markets in their tracks. My guess is that, if we did, we would see not only a far more stable stock market but also a far more stable economy. There would no doubt be blips up or down from time to time. But the blips down would cause rising companies to take advantage of lower prices and the new economic activity would bring about an upward blip that would keep things running smoothly forward.
It would be a better world.
No more bull markets!