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Jim, Gerrit, and Tom, I think you better take a look at the other side of
the coin. If you want to know why the market has kept going up and will
continue to do so, you can start with the most basic principle of economics-
supply and demand.
The supply in this case is the amount of shares of stock available to the
public to be purchased. Despite all the IPOs you hear about on a daily
basis, the amount of shares available in US stock markets has only
marginally increased over the past ten years. Why? Because while some
companies have been selling shares, many others have been buying their own
shares back (or eliminating shares because of mergers). GM recently
announced it was buying back 5 billion dollars worth of shares. That's 5
billion dollars that will now go chasing other shares of stock that are
still available. That one buyback alone will more than offset all the Yahoo
and Excite IPOs of this world.
The demand side of the equation is a little more interesting. Many people
like to compare this market to the one just before the 1929 crash, but
they're overlooking one very important point. Back then, investors were
only required to put down as little as 10% of the face value of the stock in
order to buy it. I don't know what the exact figure was, but I do know that
just before the crash an enormous amount of that market value was built on
"paper" profits that investors just kept "pyramiding" back into the market.
People truly were speculating with money they didn't have. That simply
isn't the case today.
The vast majority of stock now owned in this country was purchased with
"real" money, not paper profits. I again don't know what the exact figures
are, but I do know that the dollar value of outstanding shares that were
bought on margin as a percentage of the whole market is not only low, but
has actually DECREASED over the past few years. Who was it that panicked
last October and sold during the Asian crisis? It was primarily hedge
funds, who did have highly leveraged positions. Individual investors
actually BOUGHT during the sell-off.
This raises an interesting question- where exactly is all this "real" money
coming from? The answer: the baby boom generation. The BB generation has
just begun to enter the phase of their professional careers where their
earnings are greatest. These earnings, combined with the fact that their
children are now out on their own and their parents are covered by
government programs, means these boomers have LARGE amounts of disposable
income. In other words, they are not only in their peak earning years,
they're also in their peak SPENDING and SAVINGS years. Their savings
directly fuel the market by increasing demand and therefore the price of
stocks, and their spending indirectly fuels the market by keeping the
economy humming (just look at the sales of RVs!).
Anyone who doubts the effect the BB generation is having on the stock market
should draw a line chart of the number of births per year in this country
starting in 1940, and shift those numbers forward about 48 years. Thus, the
number of people born in 1950 would appear on the chart above the year 1998.
On top of this draw a line of what the S&P 500 has done over the last 50
years and guess what you find? That's right, they're absolutely identical.
There are plenty of bumps along the way, but they both slowly inch their way
upward and then begin to take off almost exponentially in lockstep. A
picture of this chart appeared in TASC about a year ago (maybe John can post
it to the list for us...)
Of course, a cynic will say "this huge pool of savings may exist and
continue to grow, but who says people will continue to buy US stocks with
it?" My answer would simply be "where else are they going to put the
money?" People could suddenly decide to buy a lot more bonds, but we all
know there's a direct relationship between stock prices and bond yields. If
bond yields get cut in half because of a massive influx of money, what do
you think will happen to housing and auto sales? What will then happen to
the stocks in the auto, housing, steel, rubber, lumber, plastic, glass, and
copper industries. You get the picture. I guess a lot of people could
suddenly decide to invest overseas, but I think the recent Asian meltdown
has removed that temptation for the next ten years or so.
This is why all the talk about the stock market being "overvalued" is, with
all due respect, meaningless. Overvalued compared to what? The past? That
kind of thinking doesn't take into account the massive growth in the pool of
savings over the past 15 years. You're comparing apples to oranges. As
long as large amounts of savings continue to be generated, people need to
put the money somewhere. It doesn't matter if the average dividend falls to
.001% (that's still a better return what you get if you stick the money
under a mattress), people are still going pump their savings into the stock
market.
Just out of curiosity, how many of you out there that think the market is
overvalued are currently writing OEX call options long term? Not too many,
I bet.
By the way, in case you're wondering where the baby boomer / S&P chart says
the stock market will end its hyper-up move and begin to fall... around the
year 2007.
Bruce
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