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Lies can last for a long time, but they are still lies



November 13, 2007 – Comments (3)

So, I am calling the "truth" that the stock market always goes up and you are always better off investing there a lie.

The last twenty years of the stock market has ridden a world credit bubble and the market has risen beyond reasonable valuations.  Today it sure does look like it doesn't really matter when you invested, only that you did invest to have improved your financial position.

But... what about the level of earnings on the market?  I was reading an article,, and point 4 which I've copied below is worth strongly taking into consideration,

"#4. Consensus Values

Like their politicians, democratic societies tend to deserve the financial markets that they get. After all, financial markets express the values of society. Analysts may argue that "fundamentals" and "historical benchmarks" set the valuation envelope for asset market levels and trends. Yes, historical statistics have their uses, but frankly, they tell us little about the secondary and tertiary conditions that gave rise to them in the first place. For example, the average dividend yield of the S&P 500 over the 20 years between 1940 and 1960 cannot be directly compared to the average yield that existed during the 2 decades between 1987 and 2007. (Respectively, 5.27% and 2.24%, the former more than twice the latter.) These statistics embrace many differences, most significantly two different societies -- two sets of values and beliefs. In this comparison, the former society was a risk-averse, industrious, post-war society with modest expectations that couldn't be more different than the over-indebted, over-inured household of today. As another illustration, Figure #3 shows the changing value of labor income versus stock market capital."

The part that really gets me is the 5.27% yield versus the 2.24% yield, or a yield that was more than double, actually 135% higher.  Say the Dow at 13,000 does in fact give a yield of 2.24%.  The Dow would only be 5500 to give that 5.27% yield.  If you were to assess the Dow with a reasonable yield and a comparable yield to say the 1940-1960 period has the Dow really been that great?  

I say it has not performed on equitable fundamentals and over the years people have accepted more and more risk for less and less return. 

Some thing else in the article that got my attention,

"A heavy reliance on capital gains for income and reported profits."

My Jones Soda post last April,, I torn into just how the company was making its money and deferred taxes and interest on an equity offering was where more than half of the income came from, and at the time the stock was trading at an insane P/E of over 100, so the market leverage interest earned to more than 100 times its value.  Interest on the equity offering isn't capital gains, but it isn't business earnings.  Many companies have non-business items fluffing their apparent P/E and trading based on an artificial P/E.

I am shocked when I look at companies and how many have non-earning kinds of items making up their profits.  This is deadly for preservation of capital...

The safehaven article is well worth a read.   

3 Comments – Post Your Own

#1) On November 13, 2007 at 8:46 AM, Gtrinvestor (94.03) wrote:

There are some valid points above, including the irrational exuberence of JSDA and the declining dividend yield; however, I'm not sure what action you propose we as investors take, or demands we should make? 

If your point is that the US is not the growth engine it once was, I agree; clearly, the real growth is in overseas markets.  Hopefully US companies can take part of that growth... but only through investment in overseas companies, capital & labor.  As such, the C-suite of these international companies must make a decision... pay higher dividends, or invest retained earnings into future overseas growth?

I believe in the end that it is a company by company decision to make on these points.  What I don't like to see are companies squandering retained earnings to purchase companies w/ no efficiencies to be gained.  This often happens when C-suite execs simply want to make their companies bigger to justify higher salaries; however, again this is a company specific issue.  However, I think this point is lost on many analysts and investors who only see that "revenue is growing", but at what cost?

In conclusion, investing in large US centric companies is a recipe for stagnation and or failure for your investment dollars(e.g., US airlines or US car companies), which conforms to what I think your point above.  However, investing overseas provides great returns but yes, at more "risk", but w/ no risk, there is no reward.

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#2) On November 13, 2007 at 9:16 AM, Gtrinvestor (94.03) wrote:

As a caveat, all of the above being said, I think that overseas markets are probably a bit inflated right now and will most likely correct in the short term (or really really correct in the case of the China bubble), but long-term, overseas in emerging markets is the way to go.

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#3) On November 13, 2007 at 9:45 AM, dwot (28.81) wrote:

I would propose that every investor research and understand credit bubbles.

The world credit bubble has caused asset price inflation beyond all reasonable measures of valuation all over the place and the credit bubble is starting to unwind. 


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