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Hope springs eternal in the human breast – and nowhere more so than in the hearts of the permabulls on Wall Street. That’s the only conclusion we can draw from the appearance of James Glassman on the US money channels in the last few weeks.
You may recall Glassman from the days of the dotcom bubble when making easy money from equities was just a case of buying into any over-promoted junk with a trendy name, a photogenic founder and a cash burn rate that would worry NASA. In the midst of this madness, Glassman co-wrote a book called Dow 36000, in which he argued that shares would soon triple from their already-elevated levels.
Fortunately for him, he published it in May 1999, giving him one profitable year among the business bestsellers before reality intervened and made him look rather ridiculous. But, Glassman still believes that stocks are highly undervalued and is calling for 36k within fifteen years or so.
And of course, with the financial press in a frenzy about the Dow hitting a new, all-time high, plenty of people are willing to believe him…
Glassman’s argument seemed rather silly when he first floated it, even by the standards of an era when all the bright young things were claiming that ‘earnings didn’t matter’ and fund managers were stupid enough to believe them. Now that some – though not all – of those delusions have gone, it looks downright ridiculous.
The 36k theory was based on some very Panglossian views about future growth and interest rates, and among other things, the rather bizarre idea that investors should demand virtually no risk premium for holding large-cap equities instead of bonds. But the fact is that on more pragmatic assumptions the Dow may not hit 36,000 in our lifetimes.
As Edward Chancellor points out on Breakingviews.com, if you work on the basis that the Dow’s earnings will increase by a bit under the long-term average rate of US economic growth – say about 3% – and suppose that the p/e ratio stays the same as it is at present, you end up with the Dow reaching 36,000 around 2035 (also assuming that buybacks boost growth by around 1% a year).
But the index’s current p/e of 22.5 is well above the norm, while corporate profits are at a record share of GDP. If both revert to their long-term averages, it will be well into the middle of the century before it reaches Glassman’s target.
Of course, even if you ignore the decision to trot out such as discredited prophets as Glassman, some of the hyperventilating media coverage of the Dow’s new high has been baffling. For starters, few people point out that it’s just a nominal high – someone who bought at the peak in 2000 would be sitting on a loss of around 20% in real terms. Once you factor in dealing costs, you’d have been better off leaving the cash under your mattress.
Secondly, while the Dow is a powerful symbol for America, it’s not reflective of the broader US corporate sphere because of its bias towards very large old-economy stocks. It tells us little about how well most companies are doing. The S&P500, which is much more of a national barometer, is about 13% below its 2000 highs.
Lastly, the fact that the Dow is based on prices on rather than market caps means that a gain in a high-priced stock has a much bigger impact than a fall in a low-priced stock. To see the importance of this, note that although the index may be at an all-time high, few on its constituents are. Twenty of the 30 are still below their 2000 prices. The bulk of the Dow’s recovery is down to a handful of high-priced stocks – most notably storming performances from Altria (up 220%) and Caterpillar (up 150%).
With the US economy looking increasingly shaky, talk of 36,000 or anything like it is just very wishful thinking. The financial media should be pointing this out, rather than giving airtime to the Glassmans of this world. But they won’t – it’s human nature to be optimistic for as long as possible, particularly when there’s money at stake.
For a more pragmatic look at why the collapse of the housing bubble means that both America and the global economy are heading into very tricky territory, you can read James Ferguson’s cover story in this week’s issue of MoneyWeek, out on Friday.
And if you’re not a subscriber yet, you can get access to all the content on the MoneyWeek website and sign up for a three-week free trial of the magazine, just by clicking here: Sign up for a three-week free trial of MoneyWeek.
Turning to the markets…
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The FTSE 100 ended Friday slightly lower, but was kept above the 6,000 mark by a recovery from Partygaming and M&A activity in the utilities sector which saw Severn Trent and Kelda make some of the biggest gains of the day. The index closed 3 points weaker at 6,001. For a full market report, see: London market close (/file/19631/london-close-footsie-keeps-head-above-6000.html)
On the Continent, the CAC-40 was 6 points lower in Paris, ending the week at 5,282. In Frankfurt, the DAX-30 closed at 6,085, a 10-point gain.
On Wall Street, the Dow Jones ended its run of gains, closing 16 points lower at 11,850. The S&P 500 was 3 points lower, at 1,349. And the Nasdaq was down 6 points, at 2,299.
In Asia, the Nikkei paused following a week of stellar gains, ending the day 13 points lower at 16,436.
Crude oil was trading at $60.18 this morning, whilst Brent spot was almost 3% higher today, last trading at $59.60.
The price of spot gold had rebounded somewhat today, reaching a high of $579.80 in earlier trading. It was last quoted at $577.80/oz.
And in London this morning, Incomes Data Services forecast bigger pay increases this year as retail price inflation (RPI) reaches 4% by December, driven by rising energy bills. Basic wage increases for private sector companies are set to be in the range of 3 to 4.5%, up from a 3% median last year, the reasearch group said. However, public sector pay is not expected to increase by more than 2%.
And our two recommended articles for today…
Where next for oil?
– The question everyone has been asking lately is: has the oil price peaked? In order to answer this, says Brian Durrant, we need to look at the whole cycle. For the key trends on both the supply and demand side – plus the longer-term effect of recent conflicts – see: Where next for oil?
What Bernanke really thinks about the US housing market
– Investors has high hopes for Bernanke’s speech to the Economics Club in Washington DC. He was expected to speak about the lack of personal savings and – by extension – give a clear line on the US housing market. So did he deliver? To read Jeremy Batstone of Charles Stanley’s analysis of his comments, click here: What Bernanke really thinks about the US housing market