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I apologize to the people I told privately I would comment on the US trade
deficit next (don't worry, it's coming). I felt this message was more
relevant to what's happening in the market right now. If a lot of this
message looks familiar to members of the list, it's because I originally
posted it back in March of this year, but I felt the newcomers might enjoy
an updated version.
Market Bubble / Bear Market:
If you want to know why the market has been going up over the past several
years 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). Some time ago GM
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.
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 46 years. Thus, the
number of people born in 1950 would appear on the chart above the year 1996.
On top of this draw a line of what the inflation-adjusted S&P 500 has done
over the last 50 years. 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 a couple of years
ago.
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 Asian market meltdown
has removed that temptation for the next ten years or so. When you invest
overseas, you're not only betting on a foreign market, you're betting on a
foreign currency. A lot more risk relative to the reward.
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%, people are still going pump their savings into the stock market and
leave it there until they retire.
There is, however, a bubble growing in this country in relation to the stock
market that no one on this list is talking about. It is the bubble of real
money sitting in the pockets of mutual fund managers. Even as the market
has fallen over the past couple of weeks, money continues to flow into
mutual funds at near record levels, to the tune of over $5,000 EVERY SECOND.
That means another $300,000 has flowed in during the single minute it has
taken you to read this letter. If you don't believe me, just ask a few of
your friends (and yourself, for that matter) whether they have STOPPED
putting money into their 401K or their IRA over the past few weeks. I can't
find a single person who says yes.
Fund managers have been sitting on this money because they think they're so
smart they can time this correction and help their investors in the process
(although history clearly shows they aren't). These same people, however,
are fully aware of what happens to stock fund managers who invest too
conservatively and miss the big bull runs (like Jeffrey Vanick, who was
fired as the head of Magellan).
My personal opinion is that the market will continue to be rocky until the
Clinton scandal is resolved one way or the other. Things such as corporate
earnings are devils the market knows, the scandal is a very big unknown, and
is therefore very hard to factor into stock prices until it is resolved. As
soon as this market does turn back upwards, however, you're going to see a
stampede by fund managers to get back into stocks like you've never seen
before. The longer the market doesn't go up, the bigger this money bubble
becomes, and the more powerful the bull market time bomb is going to be. It
happened last fall, and it's going to happen again. Not because I say so,
but because the law of supply and demand says so.
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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