Bears of the Apocalypse I: Long-term Market Performance Perspectives
We hope you've been having a great holiday weekend. Here in the Northeast the weather's been a
tad cloudy, rainy and cool with intervals of rain and sun to break it up. Nonetheless it's a major holiday weekend and the midpoint of the summer for many. And the midpoint of the year for many investors who've been prompted to take stock - along with various media mavens. Particularly now that it's clear that the worst isn't over, the word bear is being freely bandied about and the "Lost Decade" of zero returns has been re-discovered. This isn't just about angst, agita and schadenfreude however because the real underlying economics, beyond the market gyrations, mean a whole lot to a lot of people: as in jobs, livlihoods, prospects for their children and outlook for the country. So, it being our 232nd birthday, it seemed like a good time to step back and reflect a bit. Although the Economist with its' typical flair and sense of humor does well at setting the stage with the "Four Bears of the Apocalypse".
However Jon Markman's recent column in MSN Money does one of the better jobs IOHO of summarizing things:
Bad times for good companies Even household names such as Coca-Cola are getting drubbed in this ugly market. Many careful savers and investors are vulnerable, and the trouble isn't close to being over. The collapse of market value since autumn has actually wiped out years of progress, putting all but a few big companies' returns for the decade below zero -- an extraordinary development that has jeopardized thousands of families' financial plans and possibly soured an entire generation on the stock market. Indeed, it's fair to conclude now that the bear market of 2000-02 never really ended and that the 2003-07 period of modestly higher returns will look from a historical perspective like a twitch of life in a moribund carcass. Although the story of what's gone wrong in this Lost Decade has been well documented, by myself and others, fresh evidence suggests the last pages of this sad history have not yet been penned -- not even close. For after months of denial that anything was seriously wrong, a few leading government, banking and industrial executives have decided in recent weeks that it's time to come clean and acknowledge that the collapse of the greatest credit bubble of all time will leave profits and price-to-earnings multiples impaired for years.
The URL pointer sets are to a) a very nice set of longer-term perspectives on the market and corporate profits by BeYourOwnEconomist that are worth reviewing and b) a selection of recent articles/postings on the return of the Bear (Barron's, Economist, WSJ) for the most recent re-discovery of potential long-running flaws. We propose to dig into this rather thoroughly, having touched on it before (Long-term Market Performance: It Sure Ain't What You Thought !) and noticed that in the last couple of weeks, as the markets went traveling in a handbasket, that our posts on the markets and economy were fairly popular. (Quite a Day: Prescience, Schadenfreude, Luck or Toolkit ?,Boys, Wolves, Broken Records III: Market Schizonphrenia Runs Amok ?) Given the scope of the issues we're going to shoot for a 3-parter. Part I - long-term market perspectives, Part II- long-term economic perspectives and Part III - Next Big Thing and Boiled Frog syndromes. (Our equivalent to a House episode :) ).
After the break this Part will take a pretty deep look at four different sets of market and market vs economy performance chart sets that we think are worth a tad of contemplation. What you'll find if you read on is four things: 1) a look at long-term real market performance, 2) a comparison between market and economic performance, 3) the critical importance of long-term economic performance on both the cyclical and secular performance of the markets and 4) some surprising and scary implications for the future. Which'll be discussed more fully in Part II.
LT Market Performance: Three Perspectives
The composite chart at right combines three different ways of looking at the Dow and SP500 since 1950. The first sub-chart is the one you're probably used to looking at. However it doesn't adjust for inflation which we do using the CPI in the 2nd. The 3rd sub-chart normalizes both indexes to Q195 and then applies the inflation adjustment to put them both on a common baseline and reflect real performance. The patterns remain the same but the interpretations sharpen. Notice that the "Lost Decade" thesis has real merit - real returns since '98 are essentially zero. On the other hand it's been much worse - notice the period '68-'82 was negative; and we didn't recover the '65 peaks until '95. What's the most striking thing that occurs to you looking at these charts ? One thing we wondered was what was special about post-'95 in the economy to justify such high performance ? Or was it ?
LT Performance: Markets vs Economy
Well we've probably spoiled the surprise posting all this stuff together but that same abi-normal chart takes on a whole new interpretation in our minds when we put normalized Real GDP into the picture. Now all of a sudden what we see is not that something magical happened in the underlying economy around 1995 but that we started to recover our realization of the underlying strength of the economy about then. And that as a result the markets were, in this perspective at least, playing catchup with a sustained economic performance that had been chugging along all this time and been being seriously discounted.
Markets vs Economy: Cyclical and Secular Comparison
Which really leads to the fundamental underlying question. Just how important is the economy to the market's long-term health ? After all it you'd judge by the shorter-period fluctuations and the punditing of the talking heads there's often a weak linkage at best. Take a look at this composite chart. The first sub-chart shows the YoY% changes in the SP500 vs Real GDP. Do we need to say a lot - that looks pretty dominant to us. In the long-run the Economy really....really matters. Which point is born out to some extent in the second sub-chart which shows the cumulative performance of GDP and the SP500 since 1950. Thru 1995 our earlier points about value and mis-perception seem to be born out with the major caveat that the two were basically convergent. The bubble of course is very clearly an enormous bubble. Worse and scarier we actually still haven't seen the markets return to the long-run economic performance secular trend of the economy. And we are still ahead of ourselves a fair amount. Think about that one for a while.
Return vs Growth
At this point hopefully we've convinced you that the economy really matters...on both a cyclical and secular basis. This next chart raises some really interesting questions to think about if you believe that so take a careful look. It shows the average annual return for the SP500 vs the running average real growth rate for the economy. Notice the trend lines in particular, please ! All of the themes, thesis and findings we've been building up seem to be confirmed in this new perspective, including the last one about our still being ahead of ourselves. However a new one is making an appearance. After the Korean war we entered a long period of steady growth that's been gradually slowing. And, most recently, seems to be decelerating even more. It might look slight but then again "slight" in the context of an $11T economy means $billions of income and output, millions of jobs and the well-being of a country. So slight aint' insignificant. In fact we seem to be stumbling our way to the most critical question of all - what are the structural characteristics of the economy and the long-term implications for growth ?