Once again the market is refusing to comply with the models of those who think we might have, finally, reached a market bottom. The latest bottom calling comes from Peter Brimelow and Ed Rubinstein who rely on the work of Wharton’s Jeremy Siegel, the author of “Stock For The Long-Run.”
Let’s run through the Seigelistic analysis before touching on why it might not provide much basis for confidence in the markets.
- Long Term trend is a 7% rise. Siegel’s basic insight into the operation of the market is that over the past 200 years stocks have risen on average a remarkably consistent 7% or so when adjust for inflation. This allows economic historians to look back and see that on a long term scale, the trend in stocks appears to be basically a straight line sloping upwards.
- Past performance predict future results. If Siegel’s analysis was just about past performance, he’d just be a historian. But he’s much more than that. The real insight his insight into the magic 7% is that stocks can be expected to continue to rise in accordance with the dominant trend. When we get far ahead of the trend, stocks are probably headed lower. When we get below the trend, we’ll probably head up. The idea is that stock market performance will revernt to the mean.
- We’re underperforming the trend, which means stocks will go up. Siegel’s measure of stock performance shows that we’re down to 43.1% below the trend. That’s a worse result than historic bear market bottoms in 1981 (40% below trend), 1974 (41% below trend) and 1932 (42% below trend).
- This is a once in a generation experience. Here’s how Brimelow and Rubinstein apply the analysis.
“That means that this bear market is now actually slightly worse that the 1972-1974 bear market.
Which was heralded as a once-in-a-generation experience.
But it was 35 years ago. And that’s a Wall Street generation.
Bottom line: In two centuries, Siegel’s year-end data has never shown the stock market further below trend than it is today…
Stocks are now (finally) low by historic standards. They can move sideways or go lower, perhaps by quite a lot. But they can’t go all that much lower before getting to unsustainable depths.”
So it must be time to get the broker on the phone and go long equities right? We’re not so sure. There are three serious problems with this analysis.
- Low returns. Return on investment assets in public corporations could be much lower for some time. Demand for all sorts of goods and services may be diminished for the long term as investors adjust to the fact that much of the wealth they thought had been created over the past decade was illusory.
- Bad managment. The agency costs—the costs of management looking out for themselves rather than shareholders—of pubic companies have been demonstrated to be extremely higher than previously expected. Investors may stay wary of holding common stocks for quite some time now that the agency costs have been revealed. Certainly, it would make sense to reduce equity until some new solutions are proposed to dealing with this kind of cost.
- The Uncorporation thesis. We may be in a historic shift away from the public corporation. This could mean permanently lower values for common equity as investors turn toward partnerships as providing better controls and more value.
- Banks cannot finance business. All of these are exacerbated in the banking sector, which is one of the most important sources of financing for the rest of the economy. With the banking sector continuing to struggle to accumulate capital, the rest of the economy will find it tougher to raise money for projects. Investors can anticipate this, avoiding stocks likely to suffer from this dearth of capital.
- We’re too old for stocks. An unknown portion of the historic trend for rising stocks may have relied upon generational shifts—an ever younger population investing in equities have pushed stocks up despite the lack of dividend income from those stocks. Now that the population is ageing, the value of future rises in prices may be discounted as compared to present income from less risky investments.
In sum, any analysis projecting a return to the lineal rise of stocks we’ve seen in history may provide little guidance for us here. Maybe it is different this time.