Talk About Throwing the Bull
James K. Glassman & Kevin A. Hassett
Times Business 294pp $25
By David Elias
McGraw-Hill 209pp $24.95
Charles W. Kadlec
NYIF 295pp $25.00
There's an old saying on Wall Street: When a bull appears on a magazine cover, sell your stocks and head for the hills. Yet in the last 17 years, the Dow Jones industrial average managed to gain 1,300%, to over 11,000, despite countless charging bulls on the covers of BUSINESS WEEK and other magazines. Maybe that old saw has been buried for good.
Still, with the stock market having come so far and stocks trading at valuations never seen before in the U.S., you have to take pause at what's coming out of the publishing houses this month: three books with progressively more provocative titles: Dow 36,000, Dow 40,000, and Dow 100,000. That's a series of book jackets that makes a stamping bull on a magazine cover seem more like a wobbly-legged calf on page 109.
Of course, there are perfectly good reasons why the stock market has performed so well all these years. The extraordinary economic backdrop includes a booming economy, low inflation, rising corporate profits, low unemployment, and, perhaps even more amazing, a U.S. federal budget surplus. In short, conditions are about as good as most of us can imagine them ever getting, and we've already reached Dow 11,000. What has to happen in the U.S., inside corporations, or around the globe to get us to three or four or even 10 times the current level?
Actually, conditions don't have to get a lot better to justify Dow 36,000, say James K. Glassman and Kevin A. Hassett in Dow 36,000: The New Strategy for Profiting From the Coming Rise in the Stock Market. They argue that the market already merits 36K, and that stock prices will advance toward that target over the next 3 to 5 years as investors come to that conclusion, too.
Most market mavens, even the bullish ones, do worry about sky-high valuations. The stocks in the Standard & Poor's 500-stock index, a far broader measure of the market than the 30-stock Dow, sell at more than 30 times last year's earnings. This is double the long-term average and 40% higher than in the early 1960s, another era of strong economic growth and low inflation.
Don't sweat it, say Glassman and Hassett. Be bullish, because the market--even at a price-to-earnings ratio of 30--is a steal. By their estimates, a "perfectly reasonable price" for the market--they use this term continuously in their book, usually abbreviated as PRP--is 100 times earnings. To put that in perspective, consider that the enormously profitable and near-monopoly Microsoft Corp. trades at 66 times earnings.
Glassman, a Washington Post columnist and fellow at the American Enterprise Institute (AEI), and Hassett, an economist and resident scholar at the AEI, first put forth their bold thesis in a Wall Street Journal op-ed piece last year. Believe me, as an aging baby boomer who'll one day have to retire on the proceeds of my 401(k) account, I want to be persuaded. Unfortunately, their argument is no more convincing as a book than it was as an article.
The problem with their thesis is that to arrive at Dow 36,000, you have to accept their proposition that stocks are no riskier than bonds. And that flies in the face of what economists and B-School finance professors have been saying for decades. It also runs counter to what we observe in the market every trading day. Stocks are risky. After all, we have seen big companies lose 20% or 30% of their market value in hours because earnings came in a few pennies shy of analysts' expectations.
The argument also runs counter to what we know about corporate finance. The lenders--first the banks, and then bondholders--have first dibs on a company's cash flow. Stockholders only get paid, with earnings and perhaps dividends, if there's anything left over. In other words, bondholders have a far higher probability of getting paid. They know both the amount they will get paid and when payments will come. A stockholder may ultimately reap riches, but the timing is anything but certain. So it's not unreasonable to conclude that stocks are riskier than bonds.
Glassman and Hassett get around the short-term volatility of stocks by focusing on the long-term behavior of stocks in general. They point to the work of well-known market expert Jeremy J. Siegel, a finance professor at the Wharton School, to argue that there never has been a period of 17 years or more since the beginning of the 19th century that has not produced positive returns after inflation. Their reasoning: As long as you hold a diversified portfolio for a long time, stocks are not a risky investment. That's not a very radical idea, and in fact, it is one of the reasons why people are advised to invest in stocks for long-term goals such as retirement.
But where Glassman and Hassett deviate from convention is in their assertion that since there hasn't been any more risk in owning stocks over bonds in nearly 200 years, there never will be--and that stocks therefore deserve much richer valuations. After all, they ask, wouldn't you pay more for an investment that had less risk?
To some degree, yes. And there's no arguing that in the equity-friendly climate we're enjoying today, investors can afford to--and do--pay more. But Glassman and Hassett conclude that the estimated cash stream that may come from a stock is worth the same as predictable payments an investor can get from a bond. And that's just ludicrous. Rational investors will always compensate for uncertainty by discounting the price they'll pay for an investment. That way, the're more likely to achieve a desired return.
In contrast to Dow 36,000, the other books don't ask their readers to toss out what they know about finance or make grandiose assumptions about risk. Dow 40,000: Strategies for Profiting from the Greatest Bull Market in History predicts that the Dow will reach 40,000 in 2016. Author David Elias, who runs his own money-management firm in Williamsville, N.Y., takes an upbeat view while making a lowball forecast. All it will take to reach his target is a 9% average annual gain in stocks. That's two percentage points below the average.
Charles W. Kadlec, author of Dow 100,000: Fact or Fiction, is not making all that much bolder of a prediction. Kadlec, chief investment strategist for Seligman Advisors Inc. (and a onetime BUSINESS WEEK correspondent), puts the Dow at 100K in 2020. To jump that hurdle, the market need only gain an average of 11.1% a year, which is just slightly above what large-company stocks have done during the past 70 years.
Both Elias and Kadlec take readers down familiar routes, discussing some of the fundamental forces that are driving the long-term bull market: lower tax rates, increased globalization, the aging of the baby boomer generation, the end of the cold war, the spread of capitalism, and rapid technological advances. If you read the financial press, you already know the story. As for the stock recommendations, you can get them anywhere.
Kadlec, who has written the more eloquent of the two books, calls this new era the "Great Prosperity" and warns there's more risk to your financial health in being out of the market than in it. For the stock market to stay on the road to Dow 100,000, he writes, the historical forces that have powered the bull market must remain firmly in place. Some of them, like the technological revolution and the aging boomers, are not going away. The other trends are likely but less certain: the end of the cold war and the avoidance of a like national emergency, the continued global spread of freedom and democracy, and global economic competition among governments. Of course, trend is not destiny, and conditions can change. Kadlec warns investors to watch for a move toward higher taxes, protectionist trade policies, or global monetary instability.
Any of those factors would be the result of misguided fiscal, monetary or trade policy. And Kadlec believes that bull markets die not from old age but because of policy errors. So if, in years to come, the market gets waylaid, you could blame it on a cockeyed Congress or clueless central bank. But don't blame the authors of Dow 36,000, Dow 40,000 and Dow 100,000. That would be giving them more influence than they really have.By Jeffrey M. LadermanReturn to top