PUBLIC SERVICE ANNOUNCEMENT: THE STOCK MARKET IS NOT THE ECONOMY

I came across this article yesterday from Daniel Gross, who is executive editor ofstrategy+business. It seemed liked an appropriate follow-up to Wednesday’s article about Ben Graham’s Mr. Market, so I wanted to share it here with you:

the stock market and the economyAfter having run up about 180 percent between March 2009 and the middle of last year, the S&P 500 is off about 10 percent. The declines have been damaging to portfolios, to the egos of chief executives, to the bonuses of bankers, and to the confidence of many. And the incipient bear market has people fretting about the prospect of recession. One large bank in early February saidthere was a 40 percent chance of economic contraction. CNBC.com recently ran a story under the headline “History indicates a recession is ahead: Technician,” in which technical analyst Carter Worth said that the current movements of utilities, bonds, the S&P 500 index, and gold show a pattern that, in the past, has accompanied recession. Now, it’s not surprising there is a greater chatter about a recession. The current expansion, now in its 80th month, is getting a little long in the tooth. The wealth effect —  the idea that people feel and act differently when the value of their portfolios rise — is a real phenomenon. And when the stock market falls, bears of all stripes find they get more bookings on financial television.

But those predicting a recession are overlooking a very important factor. The stock market is not the economy. I’ll say it again: The stock market is not the economy. Sure, over the long term, stock market returns correlate with underlying economic performance. But in the short term? Hardly. Stocks more than doubled between the spring of 2009 and the middle of 2015, a period in which the underlying economy only grew about 18 percent. Meanwhile, according to Gallup, only about 55 percent of Americans in 2015 owned stocks in some form, down from 62 percent in 2008. The declines in the stock market are happening largely in isolation from other things that happen when the economy shrinks.

The Conference Board Leading Economic Index, which forecasts trajectory six to nine months out, is in positive territory. “While the LEI’s growth rate has been on the decline, it’s too early to interpret this as a substantial rise in the risk of recession,” the Conference Board reported. Consumers account for about 70 percent of U.S. economic activity. And the consumer is actually in very good shape. Retail sales were up 0.2 percent in January 2016 from December 2015, and up 3.4 percent from January 2015. (Aside from spending at gasoline stations, they were up 4.5 percent.) Autos, which are America’s largest retail and largest manufacturing sector, started 2016 where they left off at 2015 — very strong. In fact, January 2016 was the best January for U.S. auto sales since 2001.

Yes, there is some carnage in the oil and gas industry, and in the fluffier precincts of the technology world — with concomitant job loss. But in January,151,000 new jobs were added to payrolls, the 72nd straight month for job gains. At the end of December, there were 5.6 million jobs open in the U.S., close to a record. And those jobs are paying somewhat better. Personal incomerose 4.5 percent in 2015 from 2014, and wages have finally begun to rise. Theservices sector, which accounts for about 80 percent of the U.S. economy, is expanding.

You could have a recession beginning at a time when all these indicators are moving in the right direction. But it would be virtually unprecedented.

This is not to dismiss the real damage that can be done by a decline in the stock market. It inhibits capital formation, to a degree. There have been a measly four initial public offerings so far this year. And there is a real prospect for contagion from the problems in energy — to banking, to real estate, and to the companies that service them.

The problem is that for too long, and among too many, there has been a conflation of the markets and the economy, of a company’s prospects and its current stock price. I lay a good chunk of this blame at the feet of former Federal Reserve Chairman Alan Greenspan, who, during his long tenure, repeatedly rushed to the aid of faltering markets — assuming that doing so was a proxy for tending to the economy. His successors, Ben Bernanke, and, to a lesser degree, Janet Yellen, have continued this path. Many CEOs fall into this trap as well by confusing the fleeting decisions of flighty investors with the underlying strengths (or weaknesses) of their businesses. Companies are often never as great as the world thinks they are when the market pushes their stock from $50 to $200 per share in a matter of months. And they’re often not as bad as the world thinks they are when the same market pushes their stock from $200 to $100 per share in a matter of days.

LinkedIn, the online networking company, has been a darling of the recent bull market. And, unlike many other rapidly growing digital companies, it sports healthy profit margins. Last week, when it reported positive earnings that weren’t quite up to the street’s lofty standards, investors scythed the company’s stock nearly in half in a single day. In what should be a model to leaders everywhere, LinkedIn CEO Jeff Weiner confronted the decline head on. “We are the same company we were a day before our earnings announcement,” he told employees. “The question isn’t whether or not companies are going to experience this kind of issue. The question is how companies navigate through it.”

From the management of individual companies to the stewardship of the overall economy, navigational skills will be at a premium as the market seas remain choppy.



About the Author

VintageValueinvesting
Ben Graham, the father of value investing, wasn’t born in this century. Nor was he born in the last century. Benjamin Graham – born Benjamin Grossbaum – was born in London, England in 1894. He published the value investing bible Security Analysis in 1934, which was followed by the value investing New Testament The Intelligent Investor in 1949. Warren Buffett, the value investing messiah and Graham’s most famous and successful disciple, was born in 1930 and attended Graham’s classes at Columbia in 1950-51. And the not-so-prodigal son Charlie Munger even has Warren beat by six years – he was born in 1924. I’m not trying to give a history lesson here, but I find these dates very interesting. Value investing is an old strategy. It’s been around for a long time, long before the Capital Asset Pricing Model, long before the Black-Scholes Model, long before CLO’s, long before the founders of today’s hottest high-tech IPOs were even born. And yet people have very short term memories. Once a bull market gets some legs in it, the quest to get “the most money as quickly as possible” causes prices to get bid up. Human nature kicks in and dollar signs start appearing in people’s eyes. New methodologies are touted and fundamental principles are left in the rear view mirror. “Today is always the dawning of a new age. Things are different than they were yesterday. The world is changing and we must adapt.” Yes, all very true statements but the new and “fool-proof” methods and strategies and overleveraging and excess risk-taking only work when the economic environmental conditions allow them to work. Using the latest “fool-proof” investment strategy is like running around a thunderstorm with a lightning rod in your hand: if you’re unharmed after a while then it might seem like you’ve developed a method to avoid getting struck by lightning – but sooner or later you will get hit. And yet value investors are for the most part immune to the thunder and lightning. This isn’t at all to say that value investors never lose money, go bust, or suffer during recessions. However, by sticking to fundamentals and avoiding excessive risk-taking (i.e. dumb decisions), the collective value investor class seems to have much fewer examples of the spectacular crash-and-burn cases that often are found with investors’ who employ different strategies. As a result, value investors have historically outperformed other types of investors over the long term. And there is plenty of empirical evidence to back this up. Check this and this and this and this out. In fact, since 1926 value stocks have outperformed growth stocks by an average of four percentage points annually, according to the authoritative index compiled by finance professors Eugene Fama of the University of Chicago and Kenneth French of Dartmouth College. So, the value investing philosophy has endured for over 80 years and is the most consistently successful strategy that can be applied. And while hot stocks, over-leveraged portfolios, and the newest complicated financial strategies will come and go, making many wishful investors rich very quick and poor even quicker, value investing will quietly continue to help its adherents fatten their wallets. It will always endure and will always remain classically in fashion. In other words, value investing is vintage. Which explains half of this website’s name. As for the value part? The intention of this site is to explain, discuss, ask, learn, teach, and debate those topics and questions that I’ve always been most interested in, and hopefully that you’re most curious about, too. This includes: What is value investing? Value investing strategies Stock picks Company reviews Basic financial concepts Investor profiles Investment ideas Current events Economics Behavioral finance And, ultimately, ways to become a better investor I want to note the importance of the way I use value here. It’s not the simplistic definition of “low P/E” stocks that some financial services lazily use to classify investors, which the word “value” has recently morphed into meaning. To me, value investing equates to the term “Intelligent Investing,” as described by Ben Graham. Intelligent investing involves analyzing a company’s fundamentals and can be characterized by an intense focus on a stock’s price, it’s intrinsic value, and the very important ratio between the two. This is value investing as the term was originally meant to be used decades ago, and is the only way it should be used today. So without much further ado, it’s my very good honor to meet you and you may call me…